Role of the United States Securities and Exchange Commission in the EB-5 Program. Current Trends and Suggestions for Future Guidance
The EB-5 industry involves either (i) a direct investment in a project company or (ii) the formation of a new commercial enterprise entity (herein referred to as the “NCE”) in order to make (A) a direct investment in the job creation entity (“JCE”) or (B) a loan to the JCE. In each case, the intent is to create jobs to comply with the requirements of United States Citizens and Immigration Services (“USCIS”). In connection therewith, beginning in 2012, the Securities and Exchange Commission (“SEC”) has taken a far more active role in cooperating with USCIS to ensure compliance with the anti-fraud provisions of the various securities laws that regulate the sale of United States securities, even if the sale is conducted offshore pursuant to a Regulation S exemption under the Securities Act of 1933, as amended (the “Securities Act”).
Since 2012, the SEC has enhanced its engagement in the EB-5 industry by not only endeavoring to police fraud cases of which it is made aware, such as the Chicago Convention Center case and other cases thereafter, but also providing the following enforcement action and guidance in connection with the EB-5 industry:
- Announcing training of USCIS examiners to identify fraud and other discrepancies in EB‑5 offerings.
- As noted above, policing fraud when the SEC is made aware of same and taking immediate injunctive action where and when necessary in order to protect the interests of foreign investors based upon their jurisdiction with respect to the sale of United States securities.
- Providing some degree of guidance to the EB‑5 industry with respect to compliance with the Investment Company Act of 1940, as amended and issues involving compliance with exemptions and exclusions from registering as an investment advisor or broker-dealer under the Exchange Act of 1934, as amended and the rules and regulations promulgated thereunder.
- Taking actions against false advertising that implies the U.S. government or its agencies are sponsoring or endorsing EB‑5 projects when such is not the case.
- Conducting investigations on matters where the sale of securities may have been made through the use of the instrumentality of United States commerce by parties not registered as investment advisors or broker-dealers.
The SEC has four (4) main Divisions which are relevant to securities issues related to the EB‑5 PROGRAM:
- Division of Corporate Finance (handles general corporate issues, including disclosure requirements).
- Division of Investment Management (Handles 1940 Act and Investment Advisor issues).
- Division of Trading and Markets (Handles broker-dealer issues).
- Division of Enforcement (litigation and investigating arm of the SEC).
These Divisions provide continuous guidance to the public as to generally what their position is on specific EB‑5 related securities questions that may arise, although generally the SEC will not provide written direction or final advice on various issues.
The SEC and EB‑5 industry in general have publicized the fact that (i) the offering of securities under the EB‑5 program structure in either the JCE or NCE involves the sale of a security under applicable securities laws (including, without limitation, the anti-fraud provisions under Section 106 of the Securities Act, and (ii) as a result, the SEC will take immediate action if there is any potential violation related thereto. Such publicity has created a sense of comfort to the EB‑5 industry as a whole, including foreign migration agents, marketing agents as well as EB‑5 investors in general. The Chicago Convention Center case became public information not only in the United States, but also in China in particular where there was a tremendous concern about the protection of the EB‑5 investors and how quickly the monies they invested would be returned. The SEC took very quick action and, based upon pressure from the EB‑5 industry, correctly initiated actions that caused the return of EB‑5 investor capital within a relatively short period of time (the injunction case was filed in February 2013 and funds were being returned to investors approximately three to four months thereafter). The SEC went further in the Chicago Convention Center case to negotiate a settlement with the promoter, whereby the EB‑5 investors’ administrative fees that were not escrowed would be accounted for and substantially returned to the EB‑5 investors, although this still resulted in the EB-5 investors losing significant time to process a new EB-5 visa petition, including certain children that “aged out” as a result of the process.
It is noteworthy that the EB‑5 industry that represents approximately $2 Billion to $3 Billion of annual capital raising is a fraction (well less than 1%) of the total annual U.S. Securities private placement funding transactions. Accordingly, the Division of SEC Enforcement prioritizes its resources and, therefore, only concentrates on the following types of matters:
- Cases involving outright fraud.
- Cases involving discrepancies in escrow arrangements.
- Cases involving false advertising, including the references that certain projects have governmental approvals where the public is being misled.
- Investigations involving entities and individuals that may be acting as unlicensed investment advisors and broker-dealers by conducting sales activities from the United States or using the instrumentality of interstate commerce related thereto.
As a proposal going forward, we believe that the SEC should continue to update its policies as follows:
- Continue policing fraud, false advertising and other bad practices, including investigations related to the clear violation of broker-dealer and investment advisors regulations.
- Clarify the Investment Company Act of 1940 with respect to whether certain transactions are either within the 1940 Act or need to claim an exemption thereunder. There are basically only two realistic exemptions under the 1940 Act;
- 100 or less investors in the NCE or JCE and
- the so-called 3(5)(C) exemption involving real estate backed collateral.
The SEC has taken the verbal position that forming an NCE and issuing securities thereunder involves registration under the 1940 Act unless an appropriate exemption is claimed thereunder. We believe that the 1940 Act was never intended to encompass such a program since, in effect, there is really no trading in securities; rather, the EB‑5 industry dictates that a separate entity is formed to issue one class of securities that makes a loan to a project where there is no trading in securities. Some SEC staff attorneys in other divisions have expressed concern about the applicability of a 1940 Act to the EB‑5 Program. Furthermore, there needs to be clarification between the NCE debt model compared to the JCE direct investment model wherein investors directly invest in the job creating entity and no separate entity is formed. The SEC has yet to take a formal position that the direct investment in the JCE is completely exempt under the 1940 Act. Likewise, the SEC has not taken an official position whether the creation of an NCE to make an equity investment in the JCE is likewise subject to the 1940 Act, even though the NCE is being formed merely as an accommodation to a group of investors rather than having each one directly invest in the JCE, since it is much easier to administer through one common company with respect to the reporting, administration and other matters.
3. The SEC needs to provide more guidance on broker-dealer and investment advisor registration exemptions related thereto. For example, we have posed questions to the SEC based upon the standard type transaction that involves a regional center, developer or middleman undertaking activities involving offshore dealings with marketing agents who deal directly with the investors. In these cases, the applicable U.S. parties are not selling investors directly, but going through marketing agents to effectuate the sale of the EB‑5 securities entirely offshore, primarily in China (China counting for approximately 85% of the EB‑5 capital based on fiscal 2013 statistics). The concern is whether having a U.S. presence results in registration, since regional centers and middleman agents may be receiving transaction-based compensation based solely upon sales that are conducted under Regulation S in an offshore transaction that involves no “directed sales activities” from the United States.
In conclusion, we believe that it is very important that the SEC provide more detailed guidance to the EB-5 industry so that the EB-5 industry can better govern itself appropriately.
This article was written by Ronald Fieldstone and published in the September 2014 edition of Immigration Times Magazine in Mandarin. Click here to read this version.