South Dakota Loses $120 Million in EB-5 Funds

By David North, September 10, 2014

The big picture of the EB-5 scandal in South Dakota is beginning to emerge and it is not pretty

It looks like something on the order of $120 million in EB-5 funds that should be in the state's treasury are missing — a sum in that state that is, to paraphrase the late Sen. Everett Dirksen, real money.

Why moneys paid by EB-5 investors should be in the state's coffers, and why they are in some other, unknown location or locations, is an incredibly complex, South Dakota-only story that neither the local reporters nor the local politicians seem to understand very well. And it is all happening because of a huge gap in the regulation of the immigrant investor program by the Department of Homeland Security (DHS), a variable no one mentions.

This week a member of the state House of Representatives, Kathy Tyler (D-Big Stone City), held a press conference in which she laid out in detail how the scheme evolved at a small state university and how much money was involved. (She estimates more than $140 million, but for reasons I will discuss later I think it should be about $120 million.)

Ms. Tyler's hometown, by the way, emphasizes the rural nature of this state. The "big" in the town's name must apply to some rock formation, not to the city, as the population there is 467.

As background, the EB-5 program, (for Employment-Based, fifth category) is a controversial part of the nation's immigration system. It allows aliens who have invested $500,000 in a DHS-licensed, but not guaranteed, program to secure, after the passage of two years, a family-sized set of green cards. Each investment is supposed to produce 10 jobs for legal U.S. residents, but this requirement is so watered down, by legislation and regulation, that any clever economist can figure his or her way around it by estimating the "indirect" creation of jobs.

In all states except South Dakota, Vermont, and more recently Michigan, the state government plays no role in EB-5 programs. The national law mandates that most investments must be made by DHS-licensed regional centers and most of these are private, for-profit entities, but it is permissible for states to run them, too. Vermont's program has been non-controversial and Michigan's is brand-new, but South Dakota's center has been in place since the early 1990s and has been the unwanted center of attention for close to two years, as we have reported in several blogs, including this one.

The problems with the EB-5 program, over and above the state's losses, are numerous and often have caught the eye of the press (and this blogger as well). A huge beef slaughterhouse funded by EB-5 went bankrupt under suspicious circumstances, denying scores of (mostly Asian) investors both their investments and their green cards; an EB-5 middleman and former appointee of then-Governor Michael Rounds (R), died of a shotgun blast to his stomach in an act ruled to be a suicide by the Republican attorney general; that middleman, Richard Benda, overcharged the state for trips to China; and so on.

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While a generally alert press corps covered these specific aspects of the unfolding EB-5 scandal reasonably well, and while the political opponents of Rounds (now the GOP candidate for U.S. Senate) and his allies picked away at these issues and sub-issues, most missed the main point. What should have been the central issue became obscured in the maze of details and in the remarkable complexities of the handling of EB-5 finances by a man named Joop Bollen, once a state official (working for a small state university, Northern State) and later operating his own private-for-profit firm handling the same business (foreign investments in the state via EB-5).

That central issue was, and is: Why did the state of South Dakota lose $120 million or so in EB-5 fees, and why did the Rounds administration not do something about it? Ms. Tyler's press conference this week sought to focus the public's attention on the wide scope of mismanagement and the related financial losses.

She said that Bollen managed a portfolio of about 800 EB-5 investments; she said that the fees (over and above the actual $500,000 investments) came to about $140 million or (my calculation from her calculations) about $150,000 per investor. What she did not comment on was the high level of these fees (considerably above the national EB-5 average).

There are two interlocking answers to this question. First, the investors do not pay much attention to the details of these investments as their principal reason for them is the immigrant visa, not financial return. Secondly, DHS, which is very fond of this program, has never regulated the amount of fees that the middlemen can charge their clients.

As a result of these two factors, rich aliens who would complain vigorously if their broker charged more than 2 percent for a stock market transaction, will accept a 30 percent fee for an EB-5 one.

It is the result of this unusual, non-market factor that allows the collection of huge EB-5 fees by regional centers, and supplies the background for Ms. Tyler's charges of the diversion of these fees from the state's coffers, where one might expect they were headed, to wherever they actually went. The regional center, incidentally, is a de facto monopoly operation; there is no other regional center in the state.

The representative from Big Stone City then laid out in detail how Bollen, a long-time state official, built up the regional center while employed by Northern State University and became quite adept at recruiting EB-5 investors. Bollen then created a corporation he controlled, and five days after it had been formed, he, Bollen, as a state official signed a contract with his own for-profit entity to handle EB-5 matters, and EB-5 income, in the future. Neither NSU nor the state government seemed to notice this sleight of hand.

In the years that followed, the fees rolled in, but they were not deposited either with NSU or with the state treasury. Ms. Tyler estimated their total at $143.2 million. Had the self-serving contract not been signed, that money would have stayed with the state.

Now that's a lot of money in a little state. NSU runs on a budget of about $40 million a year; the state deficit the year that Rounds ended his second term as governor was about $120 million.

Ms. Tyler makes no accusations of where the money went — she contents herself with the charge that it did not stick with the state, where clearly it belonged — that's the most unattractive part of the big unpleasant picture of EB-5 in South Dakota.

Caveats. I buy most of Ms. Tyler's report but there are two problems.

While it does not really matter, as a question of policy, whether $143.2 million disappeared or some lesser sum, I think she overstated the losses by including $19.2 million in "return on capital". This is the interest that was earned on the $124 million in fees that she estimates were denied to the state. I am not sure that this is fair; it sounds a little like a negative frosting on the cake. Further, her number is based on an 8 percent rate of return, which sounds overly optimistic.

Secondly, she portrays the loss as one thrust on the state's taxpayers. That is largely correct, but what about those 800 aliens who actually paid the fees? Don't they deserve at least a mention in passing? It certainly started out as their money.

Too much of the criticism of the EB-5 program in South Dakota has been on the details of the scandal — the use of a no-bid contract, for example, to move the EB-5 contract from a public to a private entity — and much too little on the broad outline of an outrageous scheme to take an obscure flow of probably more than $100 million from the public and quietly give it to an unseen set of private hands.

Maybe Ms. Tyler's press conference will shake up the gubernatorial and senatorial races in that state.