Fraud in Connection with the EB-5 Immigrant Investment Program
Print Article- Posted on: Jul 16 2023
By: Jeffrey M. Haber
In 1990, Congress created the EB-5 Immigrant Investor Visa Program (“EB-5 Program”) to stimulate the U.S. economy through job creation and capital investment by foreign investors. The EB-5 Program offers foreign investors and members of their family an opportunity to obtain permanent residence in the United States (i.e., obtain a green card) and provides a source of financing for developers to use in, among other things, construction and business projects.
The EB-5 Program has been a material source of private investment in the U.S. for many years. According Invest in the USA, the national trade association whose members are EB-5 regional centers, [1] “between 2008 and 2021, the EB-5 program helped generate $37.4 billion in foreign direct investment to create and retain U.S. jobs for Americans, all at no cost to the taxpayer” (here).
Despite the benefits of the EB-5 Program, the incidence of fraud and abuse has increased over time.[2] Typically, where fraud is involved, a company/regional center and its financial backers will solicit EB-5 Program investors with promises of high rates of return. In some cases, the companies/regional centers guarantee that the investment is risk-free.
The Securities and Exchange Commission (“SEC”) has identified a set of common violations of the securities laws arising from the misconduct surrounding the EB-5 Program. These violations include: (a) false or misleading statements in placement memoranda, subscription agreements, advertisements, and sales brochures in violation of Section 10(b)-5 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”); (b) theft or misuse of investor funds in violation of Section 17(a) of the Securities Act of 1933, as amended; and (c) improper solicitation of investors by unregistered broker-dealers in violation of Section 15(a) of the Exchange Act.
Due to the incidence of fraud, the SEC has released an investor alert to warn investors about potential scams in EB-5 offerings.[3] The USCIS has also noted that “fraud – in the form of embezzlement, securities violations, investment schemes, and criminal conduct – has plagued the Regional Center program since its inception.” In a letter to then-President Trump, Senator Charles Grassley also noted that the EB-5 Program had “become riddled with fraud and serious vulnerabilities that present real national security concerns,” and strayed materially from its intended purpose of bringing investment to areas that need investment opportunities the most.[4]
Given the incidence of fraud and abuse, it is not surprising that EB-5 investors have brought suit against companies/regional centers, claiming violations of the common law, as well as federal law.
In Youyi Chen v. 215 Chrystie Venture, LLC, 2023 N.Y. Slip Op. 50716(U) (Sup. Ct., N.Y. County July 13, 2023) (here), 37 foreign nationals (“plaintiffs” or “investors”), brought an action against 215 Chrystie Venture, LLC, 215 Chrystie Investors, LLC, The Ian Schrager Company, and The Witkoff Group, LLC (“defendants”), asserting six causes of action – fraud, negligent misrepresentation, breach of fiduciary duty, unjust enrichment, accounting, and constructive trust – based upon their investments in a commercial development under the EB-5 Program. Defendants collectively moved to dismiss the complaint in its entirety, pursuant to CPLR §§ 3211(a)(1), (3), and (7). The motion court granted the motion to the extent of dismissing the fraud and negligent misrepresentation causes of action as against all defendants, and denied the motion to the extent that plaintiffs alleged sufficient facts to survive dismissal of their claims related to causes of action for breach of fiduciary duty, unjust enrichment, accounting, and constructive trust as against all defendants. We examine the court’s decision as it pertains to the fraud and negligent misrepresentation claims.
Background
Plaintiffs are Chinese nationals who took part in the EB-5 Program to secure permanent resident status in the United States. They described themselves as unsophisticated investors with little or no proficiency in English and with limited knowledge about the U.S. real estate market.
Each plaintiff invested $549,000 in Manhattan Chrystie Street Development Fund, LLC (“MCSDF” or the “fund”), a non-party to the action, for the development of a project that included the construction of a new mixed-use commercial building containing what would become the 374-room PUBLIC Hotel and 11 residential condominium units. Upon receiving plaintiffs’ funds, MCSDF was to aggregate the equity investment portion of plaintiffs’ money and invest that money in 215 Investors — for which MCSDF was to receive a “preferred equity” interest in 215 Investors. Plaintiffs alleged, however, that they never acquired membership interests in 215 Investors, and that, instead, their interests were solely connected to MCSDF.
215 Investors was managed by 215 Venture, LLC (“215 Venture” or the “managing member”), which was jointly controlled and owned by the Witkoff and Schrager entities. Plaintiffs alleged that all defendants had a direct interest in inducing plaintiffs’ investments in MCSDF, as such funds would directly flow to them; accordingly, plaintiffs alleged, all defendants were the ultimate beneficiaries and recipients of the funds invested by plaintiffs. Plaintiffs also alleged that defendants acted as promoters and solicitors for the investments and that Witkoff and Schrager were touted as having specialized skill and expertise in the U.S. real estate market generally, and in the development and operation of the project specifically. In their capacity as promoters with specialized skill and expertise, Witkoff, Schrager, and 215 Venture were allegedly responsible for compiling, crafting, and confirming the accuracy of information presented to plaintiffs concerning the nature and structure of their investment in the project.
Prior to investing in the project, plaintiffs received a confidential private offering memorandum, dated June 14, 2013 (the “OM”), describing how the project would function, what the project would do, how the project was to be financed, and the financial and operational details of the investment. The OM was intended to convince investors to invest in the project. The OM was not drafted by defendants, but instead, it was drafted, approved, and distributed by MCSDF, which, as noted, was not a named defendant in the action. Notwithstanding, according to the OM, certain “information, financial statements, statistics, and graphics” were “compiled” by defendants, and “information about the Owner and the Project contained [in the OM] was also provided by [Defendants].” With respect to defendants’ involvement in compiling and providing information for the OM, the OM also stated that it was “not an offering of [Defendants]” and that “none of the [Defendants] nor any of their respective affiliates [made] any representations or warranties with respect to the adequacy of the disclosures in th[e] [OM].”
The Contentions of the Parties
Plaintiffs contended that the OM contained material misrepresentations and omissions attributable to defendants which were reasonably relied upon by plaintiffs in deciding to make their investment in the project. First, the OM allegedly represented that plaintiffs’ investments would be used to purchase a preferred equity interest in 215 Investors, such that plaintiffs would have an indirect equity interest in the project and would share in the profits and losses associated with the completion of the project. Plaintiffs alleged that statements in the OM regarding the nature of their investment were false and misleading when made since plaintiffs’ investment was effectively nothing more than an unsecured junior loan.
Regarding the use of proceeds, the OM provided that “[t]he proceeds of the Qualifying Investment will be used by the Venture to fund the construction costs of condominium and hotel portions of the Project.” Plaintiffs maintained that this representation was misleading and untrue when made, since between 2015 and 2019, instead of using the investments to fund the project, defendants diverted to themselves and their own use approximately $109 million from the project funds. The OM also allegedly falsely represented that defendants were putting their own capital at risk and that such capital would remain at risk throughout the life of the project.
Plaintiffs further contended that the OM was misleading when made in that it falsely summarized the terms of the 215 Investors’ operating agreement (the “OA”). According to the complaint, defendants drafted the OA and were responsible for summarizing it in the OM and confirming the accuracy of statements concerning the OA in the OM. The OA allegedly reinforced the false and misleading narrative that plaintiffs would have an indirect equity interest in 215 Investors by investing in MCSDF, and that MCSDF would be treated as a “member” of 215 Investor. Plaintiffs also alleged that the schedules attached to the OA were false and misleading in that they omitted material information.
Defendants argued that plaintiffs did not have standing to pursue any of the claims because they lacked privity with defendants. Defendants argued that all claims asserted by plaintiffs fell into one of two categories: they should be asserted against MCSDF (which was a non-party to the action) or are derivative in nature and belonged to MCSDF, and not to plaintiffs individually – plaintiffs neither asserted direct claims against, nor derivative claims on behalf of, MCSDF. Therefore, argued defendants, plaintiffs lacked standing to pursue their claims.
Defendants also argued that plaintiffs’ claim for fraud should be dismissed as no statement or representation made in the OM could be attributed to defendants, as the OM was drafted, signed and distributed by MCSDF.
Defendants further argued that they did not owe plaintiffs any special or fiduciary duties, even if plaintiffs could establish standing. According to defendants, plaintiffs were not investors in (or members of) any of defendants, including 215 Investors, and under New York law controlling members and managers of LLC’s do not owe any special or fiduciary duties to non-members. Given that plaintiffs have not pled any recognized special or fiduciary relationship with defendants, defendants maintained that plaintiffs’ claims for, inter alia, negligent misrepresentation and breach of fiduciary duty should be dismissed, as each requires the existence of a special or fiduciary relationship between the parties.
Plaintiffs argued that defendants’ conduct constituted fraud because plaintiffs were induced by defendants’ misrepresentations and omissions to invest in MCSDF and then in the project. Plaintiffs maintained, based on representations made in the OM, that they were investing as indirect equity owners in 215 Investors and thus would have shared in distributions of profits (and incurred any losses) from the development and operation of the project. Instead, plaintiffs argued, their investment was treated as an unsecured junior loan, rendering payments owed to plaintiffs due at a significantly later date than payments owed to investors with equity interests in the project. Considering their lack of sophistication, plaintiffs argued, it was reasonable for them to rely on statements provided in the OM, especially since defendants were touted as experts with specialized skill and knowledge. Plaintiffs further argued that had they known of the true structure of their investment, they would either not have invested in the project or would have insisted on substantial changes. Alternatively, plaintiffs argued that defendants’ misstatements and omissions constituted negligent misrepresentation.
The Motion Court’s Decision
The motion court dismissed the fraud and negligent misrepresentation claims.[5]
The motion court found that “dismissal of the fraud claim [was] warranted given plaintiffs’ failure to allege any statements made directly by defendants to plaintiffs.”[6]
The motion court found that the OM, which was used “to solicit plaintiffs’ investment in MCSDF, was drafted, approved, and distributed exclusively by MCSDF.”[7] Plaintiffs did not “allege that any of the defendants had any direct involvement with the process of drafting, approving or distributing the OM,” said the motion court.[8] That failure, noted the motion court, was underscored by the OM, which specifically stated that the OM was not an offering of the defendants.[9] Thus, any claims related to the falsity or misleading nature of the OM, held the motion court, were properly asserted “only against MCSDF, and its principals, none of whom [were] defendants” in the action.[10]
The motion court held that to the extent 215 Venture allegedly provided false information to MCSDF regarding the OA — and to the extent that MCSDF included such information in the OM — such claims belonged to MCSDF, not plaintiffs.[11] “And although defendants certainly had a hand in drafting the OA,” noted the motion court, the OA was “an arms-length agreement between 215 Venture and MCSDF,” which plaintiffs did not allege contained any representations intended to be relied upon by third parties.[12] “The OA simply sets out the governance of 215 Investors, including the rights and obligations of each member,” observed the motion court.[13] Since plaintiffs did not allege that they were members in 215 Investors, explained the motion court, “the OA cannot possibly form the basis of fraud-related claims between plaintiffs — non-parties thereto — and any of the defendants.”[14]
Since plaintiffs’ negligent misrepresentation claim was “exclusively rooted in statements allegedly made by defendants in the OM and OA, which [were] the exact same statements that formed the basis for plaintiffs’ fraud claim,” it suffered from the same infirmities as plaintiffs’ fraud claim, held the motion court. [15] “[N]o statement in either of the two documents was ever made by defendants directly to plaintiffs,” said the motion court.[16] Thus, concluded the motion court, “[t]o the extent that the OM or OA contain[ed] any misrepresentations — whether fraudulent or negligent — those misrepresentations were made either by defendants to MCSDF or by MCSDF to plaintiffs” and, therefore, were not actionable.[17]
Takeaway
In prior articles, we have discussed the pleading requirement that the plaintiff identify a statement or omission claimed to be false or misleading in order to survive a motion to dismiss.[18] As noted above, in Chen, the motion court found that plaintiffs failed to satisfy this requirement.
Of interest to us is the absence of any specific discussion of the principle that a defendant can be liable to a plaintiff for fraud when the plaintiff relies on the misstatement or omission of a third-party who acts as a conduit for the fraud. We have examined this principle of law on numerous occasions.[19]
In Pasternack v. Laboratory Corp. of Am. Holdings, 27 N.Y.3d 817 (2016), the New York Court of Appeals held that third-party reliance does not satisfy the reliance element of a fraud claim unless the third party “acted as a conduit to relay the false statement to plaintiff, who then relied on the misrepresentation to his detriment.”[20] In other words, the alleged misrepresentation or omission does not need to be made directly to the plaintiff so long as the statement was made with the intent that it be communicated to the plaintiff by a third party and the plaintiff relied on the representation or omission to his or her detriment.
Based upon the motion court’s discussion of the facts and allegations, it seems that the misrepresentations and omissions in the OM were made for the purpose of being communicated to plaintiffs, as investors of the project, in order to induce their reliance thereon. As noted in the discussion above, plaintiffs alleged that many of the alleged misrepresentations and omissions were attributable to defendants. While there is no way of knowing if this principle would have changed the outcome of the motion, it, nevertheless, is interesting that the principle was not specifically discussed.
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Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.
[1] Regional centers are business that offer investment opportunities under the program. The fact that a business is designated as a regional center by the U.S. Citizenship and Immigration Services (“USCIS”) does not mean that USCIS, the SEC, or any other government agency has approved the investments offered by the business, or has otherwise expressed a view on the quality of the investment.
[2] See Hearing on “Citizenship for Sale: Oversight of the EB-5 Investor Visa Program” before the Senate Committee on the Judiciary on June 19, 2018 (here).
[3] See Investor Alert: Investment Scams Exploit Immigrant Investor Program (Oct. 9, 2013) (here).
[4] See Grassley to Trump: You Can Restore Integrity To EB-5 Visa Program (June 8, 2018) (here).
[5] As an initial matter, the motion court held that the plaintiffs did not lack standing to pursue their claims. The motion court explained that plaintiffs’ claims “go to allegedly fraudulent misrepresentations and omissions made by defendants without which plaintiffs would not have invested in the project.” Slip Op. at *4. Such claims, noted the motion court, are “properly brought as a direct claim, as the plaintiffs individually suffered the alleged harm and would benefit from any recovery.” Id. (citing, SFR Holdings Ltd. v. Rice, 132 A.D.3d 424, 425 (1st Dept. 2015)).
[6] Slip Op. at *5.
[7] Id.
[8] Id.
[9] Id.
[10] Id.
[11] Id.
[12] Id.
[13] Id.
[14] Id.
[15] Id. To state a claim for negligent misrepresentation, the plaintiff must prove that “(1) the defendant had a duty, as a result of a special relationship, to give correct information; (2) the defendant made a false representation that he or she should have known was incorrect; (3) the information supplied in the representation was known by the defendant to be desired by the plaintiff for a serious purpose; (4) the plaintiff intended to rely and act upon it; and (5) the plaintiff reasonably relied on it to his or her detriment.” Hydro Inv’rs, Inc. v. Trafalgar Power Inc., 227 F.3d 8, 20 (2d Cir. 2000).
[16] Id.
[17] Id. at *5-*6.
[19] See, e.g., here, here, here.
[20] 27 N.Y.3d at 828.
