Redeployment of Capital: A Fund Administration Perspective
By Reid Thomas, Executive Vice President, NES Financial
Over 90% of EB-5 projects use the “Loan” model. This model is where a New Commercial Enterprise uses the subscription funds raised from the investors to make a loan to the Job Creating Enterprise. Until recently these loans have typically been made with five-year terms.
However with the combination of longer, unpredictable processing times at USCIS and China visa backlogs, a five-year term is unlikely to be enough to ensure that I-829 petitions will have been adjudicated prior to repayment of loan principal. Since current EB-5 policy appears to require the subscription funds to remain at risk until the I-829 is approved or denied, the issue of redeployment of the investment funds is now front and center. Unfortunately there has been no clear guidance from USCIS as to the parameters for implementing a redeployment strategy.
As discussed elsewhere in this issue, this leaves the industry in a tricky spot with regards to both immigration and securities compliance. Moreover, it puts the investors at additional risk because it creates an enormous opportunity for fraud and abuse.
Each EB-5 investor did initial due diligence on a project and made their own investment decision to invest into a fund with a sole purpose to help finance a specific project. However with redeployment being the proposed solution to the at-risk problem, once the initial project is complete and the return of capital is pending I-829 approval, that investor’s money could end up in a completely different project. Since this situation is going to typically occur around 5 years after the initial investment, there is no realistic way that the investor could have done any quality due diligence on the second project. That makes proper administration of the fund to ensure the highest standards of security, transparency and compliance even more important.
The good news is that while this type of “blind” investment fund activity is new to EB-5, it’s not new within more traditional private equity fund markets. These other more mature markets should be used as a guide by the EB-5 industry in defining best practices that will not only ensure compliance, but will also protect investors.
As a best practice, the private equity industry uses independent third parties to administer their funds. The fund administrator can provide a wide range of services but at its core provides daily tracking, and reporting on the fund activity for the benefit of the General Partner and the Limited Partners. The use of a third party for this function enhances the security of the investor funds by eliminating real or potential conflicts of interest. It also provides an additional layer of transparency for the investors, and helps ensure that the fund remains in compliance with the investment regulations.
While these benefits would certainly be of value in EB-5, simply hiring a third party fund administrator isn’t sufficient. A fully compliant EB-5 fund administration service must meet the combined requirements of traditional investment funds with the complexity of a government sponsored job creation/immigration program. As a result EB-5 Issuers and Regional Centers need to find fund administrators and tools that are capable of dealing with a higher level of complexity.
As a baseline, quality financial reporting needs to be provided. Investors should be provided with the same level of services we all probably experience with our own investments such as regular statements and financial reports on the progress of their specific investment, and the status of the fund. In order to meet the need for both fund level, and individual level tracking, EB-5 issuers or Regional Centers should have systems and processes in place to enable for flexible reporting. There are multiple constituents involved at different levels that will often require unique reports based on the same core data. There are many capable administrators and technology solutions that can address these core requirements.
It is much more difficult to find a solution that addresses the above, while also addressing the unique requirements of the fund related to immigration and job creation. The good news is that at the time of a redeployment the job creation requirements in most cases will likely have been met. As a result the primary focus of the tracking effort is on maintaining an audit trail with evidence to support the sustaining the at-risk investment requirement. The flow of each investor’s funds as they are redeployed from one project to another must be carefully tracked and supporting elements like bank statements and wire transfer receipts must be maintained. Regular statements as to how the funds are deployed, the status of the investment and fund overall are essential to demonstrating that the at-risk requirement is being met.
Given the fact that the guidance from USCIS has been minimal, and there is little precedent to date on this issue, Issuers and Regional Centers should err on the side of maintaining “too much information” and keep extremely detailed records on the investor funds to ensure compliance with USCIS.
In addition to quality record keeping, Issuers and Regional centers should go out of their way to provide transparency to investors. At least in the near term it is very likely that the investor will not have foreseen the redeployment option, let alone have had the opportunity to consider the investment alternatives for redeployment. As such, providing the highest levels of, and the most advanced tools for, transparency is even more critical.
If on-line access to information status of the investment was not available during the initial project phase, now is the time to step it up. From a technology standpoint, investors should have the ability to access and retrieve information on-line through any one of a number of devices.
As we are well into I-829 bubble, and processing times are slowing even more, issues associated with redeployment of funds will be taking on a new prominence. Solutions to help manage the complexities of this exist, and those committed to best practices will be early adopters and embrace them. Those that decide to defer implementing these types of solutions are putting their investors at risk unnecessarily.
The EB-5 industry has matured tremendously over the last 5 years. It is clearly now a mainstream source of capital, and is being treated as such by the same regulatory bodies that govern more traditional private equity funds. It took events like Madoff to cause wholesale changes in those industries – given the current political climate around EB-5, this industry cannot afford not to embrace proven best practices.