Most EB-5 Companies are Ponzi Schemes
Most people know EB-5 as the government program used by the Kushner family's construction business to obtain financing from Chinese investors seeking a green card. The Kushners and the company they keep got themselves into trouble for making misleading promises to the Chinese. That is pretty typical. Hardly a day passes without news of an EB-5 scandal: missing money, abandoned or never-started projects, distraught investors, SEC investigations, and criminal charges. Yet nothing casts a shadow on the reassuring and confident promotional material of EB-5 Regional Centers, who still paint a glowing picture of the EB-5 program. Each Regional Center proclaims that despite the other guys who are bad actors (it is always someone else), they are different, and their projects have a high success rate. This raises the question of how Regional Centers can claim such astronomical success rates, when in fact no one knows how many billions of dollars are invested in EB-5 and no agency is holding them accountable.
The answer is that most EB-5 Regional Centers operate similarly to Ponzi schemes. They are constantly marketing and taking in new money that is recycled to pay off and forestall the losses in previous projects.
Recall that in a classic Ponzi scheme, the fraudsters are constantly recruiting new investors whose money is paid to the previous investors. Of course, the person running the Ponzi scheme takes a healthy cut of the new money, but he makes sure to return some money to previous investors, to create the illusion that the previous investment was real. A Ponzi scheme works by the constant movement of money. The key is to create the impression that the existing projects are performing, because that impression is what brings in the new money. And like a shark that sinks when it stops moving, a Ponzi scheme constantly needs to be fundraising. Similarly, Regional Centers are constantly in China fundraising and pushing their foreign agents to rope in more investors. You will never see an EB-5 operator say, "We've got plenty of existing projects to work on to ensure that our Chinese investors are paid back, so we better stop fishing for new projects." Instead, their need for constant movement is telling -- it shows that they seek fees, not performance.
Regional Centers are not a classic Ponzi scheme, but their tactics are quite similar.
The first deceptive tactic is to move money amongst their funds to create the illusion that all the funds are still alive and viable. The money is easy to move around because the same entity is typically the general partner for all of the funds. Think of it like an octopus with the Regional Center at the middle and with the funds as the legs. Each fund makes a loan to a borrower constructing a building (or a Ferris Wheel or Ski Resort) and many of these loans turn out to be losers. This comes as no surprise to anyone with finance experience, because most Regional Centers are staffed by people with no experience in high finance or investment management (sad but true), so they have no idea how to manage a distressed asset. This means that most Regional Centers find themselves stuck with nonperforming funds, but cannot admit this to potential investors, because that bit of honesty might shut the spigot of new money. But an octopus with only four working legs is not going to attract money.
The solution is to have one of the successful funds lend money to the General Partner (picture an octopus leg transferring money to the body of the octopus), who then lends it to a less successful fund, who books the transfer as a payment from the fund’s borrower. Oftentimes, the fund will actually give money to the borrower and then have the borrower return it immediately. This creates the illusion that the loan is being paid by the borrower, and the fund is alive. Nothing real has been created or advanced by a single inch, but money has been moved around to create the impression of prosperity. As long as there are one or two good funds out of a dozen losers, the money can be moved to keep the impression that every fund is viable.
A second tactic is for the Regional Center to enter into endless forbearance agreements with the borrower. Often the payments from the borrower are extended from a five-year term to a seven-year term, and then for another two years, and in exchange the Fund gets worthless new collateral. In reality the Regional Center does not care if the loan is repaid. It isn’t their money at risk. The Regional Center just wants the fees and to create the illusion of viability, because it is the illusion that brings in new money that can be used to generate money to pay or sustain the older projects. It reaches a point of absurdity. I have seen funds in default for five years still being touted by their Regional Centers as ‘success stories.’
The third tactic is to create an artificial, manufactured crisis of “redeployment.” This is when a Regional Center is undersubscribed on a project and need more money. So they arrange for another project to pay back investors early (say in year 3 of a 5 year term), thus returning to the Regional Center a pot of investor money that it must now “redeploy” to keep “at risk” in the undersubscribed project. In other words, investors put their money in project X but the Regional Center manufactures a crisis to get the money shifted to project Y which is often more risky. This is fraud because the investor had no intention of being an investor in Y. In addition, this makes the Regional Center a broker-dealer in multiple securities, an investment company that invests in securities for others, and an investment advisor who manages money for the investors – all without being registered with the SEC. “Redeployment” sounds better than “moving money from the left hand to the right without investor approval” – but there is no difference. The investor has already put their money at risk in project X and should not have to put it at risk again in project Y against their wishes. Through redeployment, a Regional Center can create the illusion that one project was so healthy it got paid back early and another found a new source of money. Note: “Redeployment” can also happen when a loan is paid back on time, but again this makes the Regional Center in control of the money to reinvest, triggering securities laws that they conveniently ignore.
Reading the web pages of EB-5 Regional Centers, you would get the false impression that their success rate is high. Actually no one knows. They don’t have to report to any regulatory authority except the USCIS, which is impervious to contact with humans and is an impenetrable bureaucracy in the worst possible sense of the word. Without the SEC or any regulator to hold their feet the fire, Regional Centers can say anything about their ‘success’ and never get called on it. It’s a giant black hole.
When the investors finally get to America, that is, IF they finally get here given that the current wait is 13-15 years, they have typically lost their money down the rabbit hole of some dead project that a Regional Center sucked for fees like a vampire and then propped up as a ‘success’ despite never paying back the investors. But more than that, the immigrants have justifiably lost their faith in America. They discovered in this country the same thing they sought to escape: the lies, the cronyism, the impenetrable agencies, the unregulated businesses, the uncaring judges and the indifferent legislators who had been paid off.
As I have said before, EB-5 is a massive violation of the securities laws. It leaves a nasty wake of unregistered public offerings, unregistered brokerage centers and boiler rooms, insane brokerage fees, foreign finders that violate FINRA 2040 by not disclosing their fees, unregistered investment companies, unregistered investment advisers, and an incentive to move illegal activity offshore to avoid regulation --- all run by people without experience in finance. It is enabled by sycophants and concentric circles of blind cheerleaders in the shape of lawyers, consultants, and promoters who feed off the corpse of Chinese money. It's a carnival of fools.
Doug Litowitz is a lawyer and professor from Chicago. Litowitz@gmail.com. WeChat: ChicagoD
