Recently, I was surprised to hear Nicholas Colucci tell the Senate Judiciary Committee that USCIS does not possess the authority to terminate Regional Centers that break laws. More specifically, Mr. Colucci testified:
I believe that USCIS has the authority right now to terminate Regional Centers involved in illegal activities, and I will prove my point in this position paper. Regional Centers that disregard U.S. law impose negative external costs on other industry participants, on government/law enforcement agencies, and upon society. By breaking the laws that govern our society and imposing negative costs on others, these Regional Centers by definition are not promoting economic growth. Therefore, USCIS can and should terminate them.
According to 8 CFR 204.6 (m)(6), USCIS will issue a notice of intent to terminate the participation of a regional center in the pilot program if a regional center fails to submit the required information or upon a determination that the regional center no longer serves the purpose of promoting economic growth, including increased export sales, improved regional productivity, job creation, and increased domestic capital investment.
To begin, I want to briefly tie together the concepts of economic growth and Gross Domestic Product (GDP). Economic growth is defined as increases in per capita real GDP, measured by its annual rate of change. GDP represents the total market value of all final goods and services produced by factors of production located within a nation’s borders. In the U.S., GDP data is produced by the Bureau of Economic Analysis and deliberately excludes economic activity derived from known illegal activities.
Costs are another important consideration in our discussion. Private (or internal) costs are those born solely by the entities who incur them. For example, if a company hires a new employee, the company knows exactly how much the employee will cost. In contrast, external costs exist in situations where the entity creating the cost is not the sole bearer of the cost. For example, a company that chooses to pollute a river instead of properly disposing of waste imposes costs upon many other stakeholders that also use the river. People may no longer be able to swim, fish, or use the water for drinking.
When you combine internal and external costs, you get social costs. Social costs are the full costs to society. When social and private costs diverge, as happens when external costs are present, we see an economic phenomenon called excess supply. In this case, the entity responsible for the external costs foists those costs on others, and continues to make its business decisions based solely on private costs. This allows bad actors to “produce” beyond their competitors until a new economic equilibrium occurs.
Negative Economic Impact Demonstrated
There has been a significant amount of research concerning the negative external costs of criminal activity. One particular example clearly shows how bad actors harm the economy.
Just over ten years ago, on June 25, 2002, WorldCom announced that its financial disclosures were fiction. Accounting fraud at WorldCom ultimately destroyed tens of billions of dollars in investors’ equity and pushed the firm into bankruptcy. When it emerged two years later as MCI, Inc., it had shed 33,000 employees, more than a third of its workforce. Its general unsecured creditors ultimately received only thirty-six cents on the dollar. While WorldCom was fabricating its financials, its rivals, Sprint and AT&T, made business decisions believing that WorldCom’s success was real. Under pressure from its own shareholders, AT&T cut $7.5 billion in costs and laid off 20,000 employees. Still unable to compete with WorldCom’s imaginary figures, AT&T split itself into three units, which were sold individually—a decision then, and now, widely viewed as value destroying. In fact, during the fraud, WorldCom’s true costs were higher than AT&T’s. Telecommunications equipment manufacturers, including Lucent Technologies and Nortel Networks, initially benefitted from WorldCom’s apparent success but suffered when the industry re-trenched after the fraud was revealed. Both suppliers fired workers and saw their equity shrink. In the aftermath of the WorldCom fraud, the telecommunications industry as a whole lost a quarter of its jobs: 300,000. WorldCom’s share price, the usual yardstick for measuring harm from securities fraud, captured none of these losses.
WorldCom might be an outlier, but it is hardly unique. By misreporting their firm’s financial results and prospects, managers credibly communicate to markets that the firm is more profitable and, importantly, less risky than it in fact is. Managers sell the lie by increasing hiring and investment, and cutting prices. Relying on false information, lenders underprice credit, employees make career and retirement decisions based on a false picture of their firm’s prosperity, and rivals make business decisions on a distorted playing field. Honest firms face the obverse side of fraud and cannot fund and employ workers for valuable projects, producing additional deadweight losses borne by all workers, primary-market investors, and beyond.
If fraud is caught, fraudulent firms spend substantial resources on investigation, litigation, damages, and fines. Many file for bankruptcy that could have been avoided in the absence of fraud, or make costly adjustments that they often shift to employees, creditors, suppliers, customers, and the government as the insurer of last resort. Rivals face doubts about their own financial reporting, which increases their cost of capital and further depresses hiring in the industry. The ripple effects are felt throughout the economy and, once aggregated, exceed the harms to defrauded shareholders by a substantial margin.
Negative Impact in EB-5 Industry
In the EB-5 context, a Regional Center that breaks laws to recruit investors without regard for securities laws, immigration laws, or even the Foreign Corrupt Practices Act (FCPA), will oversubscribe investors and projects because they can afford to do so. These scofflaw Regional Centers make their business decisions without worrying about external costs, unless they are held to account.
Consider broker-dealer violations. Some Regional Centers avoid higher costs by hiring an extensive U.S. sales staff to provide advice in connection with the EB5 offering. Typically, these employees are not licensed investment advisors, nor do they have training on the FCPA. These employees work in the U.S. and frequently travel overseas to woo investors into their Regional Center’s offerings. A Regional Center that chooses to violate securities laws by illegally employing unqualified and unlicensed U.S.-based workers to subscribe investors, pays these employees (sometimes using a per-investor payment scheme) a fraction of the amount that lawful Regional Centers pay to compete for the same investors.
Large Regional Centers that bypass U.S. laws levy a significant external cost on broker-dealers in terms of lost business revenue. For example, if broker-dealers charge 8% per investor for due diligence and placement, then each investor represents $40,000 in revenue (assuming the reduced threshold investment of $500,000). Industrywide, that would mean a total potential broker-dealer revenue stream of $177,760,000 per year. Each illegally recruited investor costs the broker-dealer industry $40,000. If a large Regional Center has 500 improperly obtained investors, that represents a loss of $20,000,000 to the U.S. broker-dealer industry!
A scofflaw Regional Center increases its competitiveness by avoiding U.S. law in other ways as well. One external cost for law-abiding Regional Centers is that broker-dealers generally require the EB-5 capital to remain in Escrow until USCIS has issued a positive I-526 adjudication. Regional Centers not using a broker-dealer have the option to release the capital at I-526 filing. This is a time savings of approximately 15.5 months.
If the scofflaw Regional Center had a $40 million EB-5 capital raise with a 6% annual loan, that time savings translates into about $3,100,000 of interest revenue during the adjudication period. Developers want access to the loan proceeds immediately. Thus, a Regional Center that avoids broker-dealers and releases capital early increases the demand for its product beyond that of law-abiding competitors.
Cutting corners gives the scofflaw Regional Center a stronger competitive advantage. According to the SEC’s FCPA Resource Guide:
Corruption is also bad for business. Corruption is anti-competitive, leading to distorted prices and disadvantaging honest businesses that do not pay bribes. It increases the cost of doing business globally and inflates the cost of government contracts in developing countries. Corruption also introduces significant uncertainty into business transactions: Contracts secured through bribery may be legally unenforceable, and paying bribes on one contract often results in corrupt officials making ever-increasing demands. Bribery has destructive effects within a business as well, undermining employee confidence in a company’s management and fostering a permissive atmosphere for other kinds of corporate misconduct, such as employee self-dealing, embezzlement, financial fraud, and anti-competitive behavior. Bribery thus raises the risks of doing business, putting a company’s bottom line and reputation in jeopardy. Companies that pay bribes to win business ultimately undermine their own long-term interests and the best interests of their investors.
How does this activity fail to promote economic growth in the EB-5 context? Keep in mind that the law requires Regional Centers to promote economic growth—rather than creating net positive economic growth. There is no threshold quantifying the concept.
As shown in the figure, the scofflaw Regional Center operates without consideration of all costs at S1 while law-abiding competitors operate at S2. The scofflaw Regional Center enjoys a higher quantity demanded and lower price than their competitors, thereby imposing significant costs on industry participants and society. While I depict this figure in the traditional manner with no numbers, we could easily assign values to the chart.
Clearly, by using basic economic principles we can show that the scofflaw Regional Center is not promoting economic growth, but imposing significant costs on industry participants and society. According to the William & Mary Law Review cited earlier:
Fraudulent firms often adopt inefficient pricing or output to mask fraud, to which their rivals respond. Unless the fraudulent firm operates a monopoly without complements or substitutes, its pricing or quantity decisions—distorted to correspond with fraudulent financial reporting—distort product markets. Professor Gil Sadka found that while WorldCom was misreporting its financials, it charged low prices and increased its market share. Its competitors, Sprint and AT&T, responded by cutting their prices and saw a substantial decline in their operating margins. Professors Bower and Gilson estimate that if WorldCom had set prices according to its real earnings, the industry could have generated an additional $40 billion in profit…
Alternately, fraud might “work” and allow the firm to cement a dominant position in the industry. Waste Management, a company that “fostered a culture of fraudulent accounting,” was charged with fraud not once, but twice. Yet it survived relatively unscathed and today dominates the market for solid waste removal, often charging monopolistic prices for its services—great for its shareholders, less so for consumers. … Professor Patricia Dechow and her collaborators confirmed empirically that fraudulent firms generally increased their scale during fraud.
A company that violates U.S. law cannot be contributing to economic growth as measured by per capita GDP. By breaking the laws that govern our society and imposing negative costs on others, these Regional Centers are not promoting economic growth—they are promoting personal enrichment at the expense of others. Terminating these scofflaw Regional Centers would be a first step toward instilling integrity and self-governance in the industry, which will certainly promote economic growth.
 William & Mary Law Review, Vol. 54 Issue 6 Article 4, The Cost of Securities Fraud by Urska Velikonja.
 Emphasis added.
 Based on 10,000 Visas, and assuming 1.25 derivatives per investor visa, there are 4,444 individual investors.