Securities law in EB-5

  • GCBI team | Contribution by Kurt Reuss | Posted on March 9, 2020 | June 11, 2020 | 4 min read

The SEC and EB-5: a brief overview.

Though the EB-5 program is run and regulated by the United States Citizenship and Immigration Services (USCIS) the program has, in recent years, fallen under the vigilance — and discipline — of the Securities and Exchange Commission (SEC). At first, the SEC was just concerned with fraud; in 2013, the agency issued an investor fraud alert. Then in 2015, the SEC began to be involved with bringing action against parties who sold EB-5 investments as unregistered broker-dealers.

Why is the SEC involved in what many see as an immigration program? It has the authority to regulate and enforce its regulations because EB-5 investment offerings qualify as “securities.” A security is any note, stock, bond of “investment contract.”

Because EB-5 investments are seen as securities — and because of strict SEC enforcement — regional centers, investors, and attorneys should be aware of and compliant with securities laws.

Investors & securities issues

An investor may be either a limited partner if a regional center has formed a limited partnership, or they may be a member if the regional center has formed a limited liability company. In both cases the EB-5 investment is seen as a security, and thus the regional center must be compliant with both state and federal regulations.

But as EB-5 investors are primarily concerned with obtaining a Green Card for themselves and their families, most are not aware of the implications of their investment being a security. They likely do not know that securities laws are in place to offer investors protection, and to bring enforcement action against violators of such laws.

Regulation D

Regional centers will wish to avoid registering their EB-5 offerings as registration is a demanding and expensive process. Thus, a regional center will want to qualify for Regulation D of the Securities Act as it gives exemption to registration.

The rules qualifying for an exemption under Regulation D include that all investors are seen as “accredited.” The criteria for an accredited investor includes: a net worth of at over $1,000,000; they have a personal income of at least $200,000 or a joint income of at least $300,000.

Rule 506(c)

Also, under Rule 506(c),  Regulation D prohibits “general solicitation,” defined as advertising — either inside or outside of the U.S. — in any medium including presentations and emails. If a regional center violates this regulation it would have to register the securities or, possibly, qualify under another exemption.

It is important to note that Rule 506(c) also applies to third parties outside of regional centers but referring investors to them: broker-dealers, finders, and immigration lawyers.

The consequences of violating Rule 506(c) is substantial — for both investors and regional centers. A violation will result in a voiding of the transaction and a loss of the Regulation D exemption. This would eliminate the regional center benefit; and for the investor this could mean. At that point, the EB-5 investment would have to become registered and this requires legal disclosures, time, and money. Neither investor nor regional center wants that to happen.

An investor, especially with today’s processing timelines, does not want to wait for a regional center to prepare and file a registration statement, and then for the SEC to process and issue approval.

For a regional center, the process requires multiple years of audited financial data. And it cannot offer a security until the registration statement is approved.

It is therefore critical that an investor does not invest in a regional center that has violated Rule 506

(c). While it is the regional centers obligation to remain complaint with this rule, an investor should always perform the due diligence necessary to ensure a regional center complies with securities laws.

Broker-dealer registration

For half a decade now, the SEC has been bringing enforcement action against unregistered broker-deals who are selling EB-5 securities. The activities that define a broker-dealer are as follows: performing duediligence, soliciting investors, negotiating offering terms, and handling of investor funds. Also, any third party receiving a transaction-based fee for any securities transaction will most likely be viewed as a broker-dealer. This is distinct from a “finder” — someone who merely provides that name and contact information of an investor to an issuer.

The liability in such cases extends to both the agent and the regional center —. Regional centers will be seen in violation of securities laws and may be issued civic and criminal fines. This is a critical issue for regional centers and they need to be fully aware of how to be compliant in working with third-party intermediaries.

Beyond the issuer, compensating an unregistered broker-dealer can impact the investment itself, and thus the investor. Such a breach of securities laws could nullify the validity of their investment and cost them their ability to be issued a Green Card.

Disclosure obligations

Full and fair disclosure is a requirement under U.S. securities law and must be consistent with an offering’s dynamics and stage of offering. While the risks associated with a project during the time of drafting the offering documents is critical, additional disclosures will often have to be made as a project may change moving forward and/or as policies change. Rescission an issue that must often be considered when there is a material change (such as an increase in the size of the offering) or a material deficiency in the disclosure documents. In such cases supplements must be added to disclose new risks and terms of an offering.

Conflicts of interest

Conflicts of interest can happen and when they do, they can be potentially explosive situations. When they do occur, they must be disclosed in the offering documents — a failure to make a material disclosure can even be viewed as fraud. How far does such a disclosure need to go? If it’s substantial enough to make an investor pause to consider whether to proceed with their investment, such a situation is considered material and needs to be disclosed.

Some securities attorneys will not represent an issuer and investor in the same project; in some cases, such conflicts can be significant enough for an attorney to be in breach of their duties to both the developer and the investor. For example, if a project is not progressing as initially planned, an attorney may have a duty to inform the investor that their opportunity to qualify for a Green Card may be compromised. However, if that attorney is also representing the developer, that attorney has a duty of confidentiality to that party. Obviously, it’a very sensitive and even dangerous situation. So much so that the SEC and other regulatory bodies have been examining EB-5 projects for conflicts of interest.

  
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