Guest Post: Why EB-5 Regional Centers Should Undertake 3rd-Party Due Diligence

Guest Post by Kurt Reuss and Rupy Cheema, Managing Partners, EB5 Diligence LLC 

The goal of any project developer is to find investors to fund new projects. Generally private placement offerings attract “sophisticated,” well-funded investors such as institutional investors, mutual funds, hedge fund operators, insurance companies or high net-worth individuals, all of which have the capacity to conduct their own due diligence to assess the viability of the project.  Additionally, the broker-dealers who underwrite and sell these securities are required by FINRA, the U.S. Financial Industry Regulatory Agency, to perform due diligence on behalf of the issuer, for the benefit of investors. Typically, the due diligence costs are borne by the issuer and structured as a percentage of the total offering.

The goal of  the average investor is to see a reliable future earnings stream while ensuring that no undue risks are taken. For some foreign investors, however, especially those whose interest is in the EB-5 project, there is one goal which is paramount above all others, and that is obtaining  green card status for themselves and their eligible family members, a goal achievable under the auspices of the U.S. Citizenship and and Immigration Service (USCIS) which allows foreign investors to invest in an EB-5 project provided that certain criterion is fulfilled.

It is for that reason that foreign investors in EB-5 projects will want to ensure that a due diligence review is carried out, because if the project fails to meet the criterion set out by the USCIS, then their ultimate goal, green card status, will not have been met. The criterion that must be met by the EB-5 project develops cannot be readily assessed by an investor, which could result in a denial of either of their petitions, meaning that they and their family could be forced to return to their home land, often causing incredible hardship for the family, not just financially, but emotionally and psychologically. For those reasons, a foreign investor must be confident that the EB-5 project he or she plans to invest in will satisfy the USCIS requirements and ultimately end up with their successful petition for green card status.

Unlike private placement security offerings, the EB-5 industry is unique in that it doesn’t require the involvement of a broker-dealer because of the exemption that allows unregistered, off-shore agents to sell these securities to foreign investors. Though they generally qualify as accredited investors, EB-5 investors are not the aforementioned “sophisticated” types, and in many cases may not even have English as a first language. This presents a strange confluence of factors: less sophisticated investors with limited English language skills wishing to invest without the involvement of a registered FINRA representative.

In the EB-5 world, regional centers often act in an advisory role that would typically be assumed by broker-dealers, namely performing the due diligence and making representations to EB-5 investors. However, unlike broker-dealers these individuals at the regional centers are not regulated by the U.S. Securities and Exchange Commission. When regional centers are also developers of the projects they sell, the need for third-party due diligence becomes even more essential for EB-5 investors.

Benefits of 3rd-party Due Diligence

Considering the somewhat modest investment of $500,000 or $1 million (of course, relative to the “sophisticated” investor types), it’s generally not feasible for EB-5 investors to pay for a comprehensive analysis of a single project, let alone the analysis of multiple projects. Moreover, from the regional center’s standpoint, it can be not just tedious but impractical when you factor in the need to supervise a multitude of visiting analysts, set up meetings with management, request documents necessary to provide a comprehensive analysis for each and every investor, etc.

By retaining a third-party to perform the due diligence review, regional centers make it easier for immigration attorneys and “foreign finders” to present their clients with an easy-to-understand yet comprehensive outline of a project’s strengths and weaknesses, inherent investment risk and its I-526 approval risk. For the less sophisticated EB-5 investor, that outline is often far more straightforward and understandable than any private placement memorandum could ever be. By having a comprehensive third-party report to distribute to investors and foreign finders, regional centers can also bolster their own marketing and solicitation efforts. The added transparency often expedites the investors’ decision making process and saves the regional center valuable time and resources that would otherwise be devoted to disseminating information to potential investors.

Since by definition every EB-5 project has inherent risk, a thorough due diligence review helps investors decide which project’s risks are acceptable to them and which are not.  On the flip side, the due diligence report can alert a regional center to any deficiencies, real or potential, in their project which would enable them to address those deficiencies prior to issuance of the report.

How Thorough does Due Diligence Need to Be?

By definition, due diligence is the care that any reasonable person would exercise in order to prevent or avoid harm to assets, property or other persons. Furthermore, it could be argued that an inadequate or poorly prepared due diligence might be more harmful than none at all, as the report itself could engender misplaced confidence in a project that may be deficient or even fraudulent.

A due diligence analysis is conducted to understand a project in as much detail as reasonably possible and moreover to take a hard look at the enterprise’s finances, strategic and operational situation and EB-5 viability, along with any problems, risks or headwinds that the project may face. A thorough due diligence review starts with a good checklist; here are ten areas that should be addressed in any comprehensive due diligence review:

1. Review of the Project’s Business Plan
2. Review of the Corporate Structure and Capital Structure
3. Assessment of the Company Management’s Background
4. Market Analysis and Sales Strategy
5. Review of the Facility, Equipment and Management Systems
6. Review of the Project’s Financial Reports
7. Review of Major Agreements and Contracts
8. Assessment of Government and Local Support
9. Regional Center and EB-5 Analysis
10. Review of the Project’s Strengths, Weaknesses, Opportunities and Threats 

Moreover, because many EB-5 projects involve construction, consultants may also be needed to evaluate construction budgets, timelines, real estate title, permits and other important approvals. Finally, because EB-5 investors may not have English as their mother tongue, it makes sense to have due diligence reports translated into various languages.

The Cost of Due Diligence

The cost of a comprehensive project review can range anywhere from $10,000 to $50,000, and is dependent upon the size and complexity of the project. Most mid-sized project reviews typically cost around $20,000.

Conflict of Interest Concerns

Potential investors may worry about the possibility of a conflict of interest if a due diligence analysis is conducted and paid for by a regional center or project developer, or if it is performed by a registered broker-dealer who is retained by the issuer. Investors might suspect that the report could be unduly influenced by the agency relationship. Fortunately, those concerns are invalidated thanks to FINRA, which specifically prohibits broker-dealer representatives from engaging in manipulative, deceptive or fraudulent behavior or making untrue statements of any material fact.  FINRA representatives have an obligation to provide independent, objective analysis and to report any fraud they encounter, and any information gleaned which would give a prudent person sufficient pause or which would send up a “red flag” must be further investigated. A registered FINRA representative’s failure to satisfy its investigative duties could, consequently, be considered a violation of the anti-fraud provisions of the federal securities laws and the rules of FINRA.

Simply put, FINRA registered broker-dealer representatives are tasked with performing due diligence on behalf of issuers for the benefit of investors. This “special” relationship is critical to the proper functioning of the securities industry.