Part I: EB-5 Offerings Do Not Fit Standard SEC Registration Requirements
by Victor Shum & Catherine D. Holmes
- The SEC has not provided clear guidance on how to comply with U.S. securities laws requiring registration as a securities broker-dealer, investment company or investment adviser when conducting EB-5 offerings
The U.S. Securities and Exchange Commission (SEC) has stated in open meetings with the United States Citizenship and Immigration Services (USCIS) and the Association to Invest In the USA (IIUSA), the trade association for the EB-5 regional center program, over the past two years that EB-5 investment offerings are subject to U.S. securities laws, even though EB-5 investments are offered primarily outside the United States to persons who by definition are not currently U.S. residents but are seeking to become U.S. residents as a result of making their investment in an EB-5 offering. However, the SEC has not provided any specific guidance to the EB-5 investment community on the ways in which they can comply with the registration requirements that apply to the registration requirements for securities broker-dealers, investment companies or investment advisers under U.S. securities laws, other than to suggest that they speak to an experienced securities lawyer. This advice leads to conflicting opinions among lawyers, and makes it difficult for everyone involved in the EB-5 investment market to know exactly what they are required to do in order to comply with these registration requirements under U.S. securities laws.
- There is an important distinction between SEC jurisdiction over cases of investor fraud versus the requirements for registration of broker-dealers, investment companies and investment advisers
The SEC has brought several actions against EB-5 regional center operators in cases of investor fraud. Notably, the SEC brought a securities fraud enforcement action against A Chicago Convention Center, LLC, Anshoo Sehti and Intercontinental Regional Center Trust of Chicago, LLC in 2013 (Civil Action No. 13-cv-982), in a case where the defendants had committed fraud by misrepresenting that they had all necessary building permits and contracts with several major hotel chains when they had none, substantially overstating the value of the land on which the project would be built, and making false claims regarding the experience of the principals in developing and operating hotels. Since then, the SEC has brought several other actions against EB-5 regional center operators who did not invest funds in the projects for which the EB-5 offerings were made. In all of these cases, the fraudulent conduct of the defendants was obvious, and the SEC rightfully exerted jurisdiction to protect EB-5 investors and strengthen the integrity of the EB-5 investment program. In this respect, the EB-5 community supports the actions of the SEC, because it ultimately benefits the market for EB-5 investments to have a strong enforcement policy against fraud in the EB-5 investment market.
The United States District Court for the Northern District of Illinois, in the case brought by the SEC against A Chicago Convention Center, LLC, Anshoo Sehti and Intercontinental Regional Center Trust of Chicago, LLC (the “Chicago Convention Center Case“), ruled on August 6, 2013 that the SEC had adequately alleged a domestic securities transaction, as required to state a securities fraud claim. The court in that case focused on the connections between the EB-5 investment offering and the U.S., including that the subscription agreement was required to be delivered by EB-5 investors to defendants in the U.S., the offering funds were sent to a U.S. based escrow agent, the escrow agent would only release funds upon approval of the investors’ U.S. visa applications, and the investors were bound only if the subscription agreement was accepted and countersigned by the manager of the EB-5 investment fund in the U.S. The court found that these connections could be enough to meet the “transactional” test adopted by the U.S. Supreme Court in the 2010 case of Morrison v. National Australia Bank Ltd., which limits the SEC’s jurisdiction to bring anti-fraud actions to claims that involve the purchase or sale of securities made in the U.S. or involving a security listed on a domestic exchange. The court in the Chicago Convention Center Case further noted that there is a controversy whether Section 929P(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, entitled “Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws“, has superseded the “transactional” test in Morrison, but the court ultimately decided that it was unnecessary to rule on that question.
- It cannot be assumed that because the SEC has jurisdiction to bring anti-fraud actions, this automatically means that all of the securities registration requirements apply to all EB-5 offerings
Whether the Morrison test has been superseded or not by Section 292P of the Dodd-Frank Act, it seems likely that any EB-5 offering would have enough connections with the U.S. to be subject to SEC anti-fraud actions. However, that does not answer the question of whether EB-5 offerings are subject to the registration requirements that apply to U.S. securities broker-dealers, investment companies and investment advisers. The vast majority of EB-5 regional center operators and EB-5 project sponsors have successfully raised billions of dollars for U.S investment and created tens of thousands of jobs throughout the U.S. These EB-5 financing experts are seeking to operate their businesses legally, in a market outside the U.S., where market conditions require the use of foreign emigration agents and few U.S. securities broker-dealers have any experience. These unique market characteristics are not addressed in the SEC’s existing regulations or policies regarding the registration requirements applicable to securities broker-dealers, investment companies and investment advisers.
- The SEC has provided clear guidance on exemptions from registration of securities offered outside the U.S. – but not on exemptions from registration of securities broker-dealers, investment advisers and investment companies for offerings conducted outside the U.S.
In contrast, the SEC has provided clear guidance to the question of whether EB-5 offerings are required to be registered under the Securities Act of 1933. Under Regulation S, the SEC has provided a safe harbor for any offerings conducted entirely outside the U.S. and offered to non-U.S. persons, providing that such offerings are not required to be registered with the SEC. Under Regulation D, the SEC has provided another safe harbor for private offerings conducted in the U.S. and offered to qualified U.S. and non-U.S. persons, providing that those offerings are not required to be registered with the SEC. Almost all EB-5 offerings are conducted under Regulation S and/or Regulation D, without SEC registration. These offerings are still subject to SEC enforcement action to the extent that a fraud is committed, but they are not required to be registered with the SEC. Unfortunately, there are few such guidelines provided for EB-5 offerings with respect to the registration requirements for securities broker-dealers, investment companies and investment advisers.
- Existing SEC regulations regarding registration of broker-dealers, investment companies and investment advisers do not address the market realities of EB-5 financing
There are three elements of the U.S. securities laws that are the cause of confusion and concern in the EB-5 investment community, which are: (1) the securities broker-dealer registration requirements under the Securities Exchange Act of 1934, (2) the investment company registration requirements under the Investment Company Act of 1940, and (3) the investment adviser registration requirements under the Investment Advisers Act of 1940. The problem is that each of these registration requirements was adopted specifically to address issues related to securities offerings made in the U.S. in traditional securities markets. The EB-5 financing market, in contrast, presents unique characteristics that are not present in traditional U.S. securities offerings, and that defy a clear answer under existing SEC regulations.
First and foremost, in determining the broker-dealer registration requirements to apply to the EB-5 investment market, it is necessary to take into account the fact that virtually all EB-5 investments are sold overseas, and that in China, where almost 85% of all EB-5 investments today are sold, sales are conducted through a network of licensed emigration agents and intermediaries that specialize in EB-5 investments but do not otherwise engage in a general securities business. At the present time, virtually none of these agents are associated with any U.S. securities broker-dealers. Almost all EB-5 investment sponsors will need to engage one or more of these agents directly in order to sell their EB-5 offerings.
Even if an EB-5 investment sponsor wanted to hire a U.S. broker, it would still need to hire one or more Chinese emigration agents to actually identify all of the investors necessary to fully fund an EB-5 offering being sold in China. U.S. securities brokers do not have the network of contacts or market experience to sell investments in China, and many choose not to do business at all in China. These are market realities that have to be taken into account when structuring guidelines for compliance with the broker-dealer requirements under U.S. securities laws.
In addition, the SEC has stated that the Investment Company Act of 1940 and Investment Advisers Act of 1940 may apply to EB-5 offerings, without considering the characteristics of an EB-5 investment fund. Specifically, most EB-5 investment funds are structured as an investment in one project, with no expectation of investing in any other projects. EB-5 investors typically decide for themselves which project they want to invest in, using the disclosure in the EB-5 offering documents concerning the project identified by each EB-5 investment fund. There is no such thing as a blind pool in EB-5 financing, because every investor is required to identify a single project (one project could have multiple components) on which their visa application will be based and this project is required not only to generate the requisite number of jobs per investor, but also to evidence its regional economic impact.
Moreover, the manager of an EB-5 investment fund has very limited discretion to do anything other than make the single investment described in the EB-5 offering documents with the investors’ funds. Beyond that, the manager’s role is limited to monitoring the project and providing information to investors regarding the completion of the project, tracking the creation of jobs, and making distributions of payments when the investment is repaid back to the EB-5 investors. Some EB-5 investment funds provide the manager with discretion to make another investment if the fund’s investment is unexpectedly paid off early, but that is often done to protect the EB-5 investors’ eligibility for approval of their I-829 visa petitions, because USCIS regulations require that the investors’ funds be “at risk” until they receive approval of their I-829 petition.
These characteristics of an EB-5 investment fund are not well suited for regulation under the Investment Company Act of 1940, which was intended to regulate mutual funds whose managers have discretion to invest in securities of multiple issuers over a long period of time. In addition, given the extremely limited authority of the managers of almost all EB-5 investment funds, the Investment Advisers Act of 1940 would likely not apply because of the SEC’s method of determining “assets under management”.
- How can EB-5 regional centers and sponsors comply with U.S. securities laws and thrive in the EB-5 investment market?
The SEC is still in the process of studying the EB-5 investment market, and we do not know when, if ever, the SEC will issue any guidance or policy decisions regarding the registration requirements that apply in the EB-5 investment market. In the meantime, the EB-5 investment community needs practical advice on how to comply with U.S. securities laws in a way that recognizes the realities of the EB-5 investment market. Based on our experience of helping more than 50 real estate developers and EB-5 investment sponsors obtain financing through the EB-5 immigrant investor visa program for developments throughout the U.S., our next blogs will focus on some thoughts on how to comply with the U.S. securities laws when selling EB-5 investments.