We often assume that being an accredited investor equates to being a sophisticated investor, but...
DateJuly 07, 2015
Certification With Securities Laws May Pose Problems
John Tishler: There are new processes for "approval of investment in a new commercial enterprise" in the (Grassley-Leahy) bill. One curious item; the bill states that an EB5 regional center needs to include with its pre-approval submission the documents filed with the SEC.
Normally there wouldn't be any. Form D, if you're going to rely on Regulation D, must be filed 15 days after your first sale, and obviously your first sale is not going to be occurring before you have approval of your business plan under this new regime. So that one is not particularly troublesome; but there is a much longer list of offering documents that need to be included.
Some of the items listed are routinely included with exemplar applications such as the PPM and the partnership agreement and things like that, but the bill also requires submission of marketing materials. Often times marketing materials are drafted in a separate process from the drafting of the offering materials and not everyone involves legal counsel in that process. It's often done in conjunction with agents. It’s not clear how this marketing material provision would be enforced by USCIS and what it would mean in terms of practices for drafting marketing materials.
Another thing that's required to be disclosed with the application is "policies and procedures" reasonably designed to ensure compliance with securities laws. It's unclear exactly what that will mean. That may end up being just a simple recitation of what the throughput is for the subscription agreements and the like, but it could potentially mean the kinds of things that broker-dealers have to do.
Broker-dealers are required to have extensive policies and procedures for compliance with securities laws. FINRA is an organization that establishes rules for those, approves them for new member applications and performs regular inspections of broker-dealer firms. Very few EB5 regional centers are registered broker–dealers, and it's really unclear the extent to which a requirement for these policies and procedures will blur the distinction between regional centers and broker-dealers.
I think it's fair to say that apart from routine subscription agreement inspection to confirm that investors satisfy the requirements of either Regulation S or Regulation D, most regional centers are not set up with policies and procedures akin to those of a broker-dealer, and most do not have budgets or staffing to put broker-dealer equivalent policies and procedures into effect. It will be very interesting to see how that plays out.
Finally I want to point out that these “business plan applications” require certification that the regional center, the new commercial enterprise and all of the promoters and agents of the offering are in compliance with SEC laws. There's a temporal aspect to that, which is, I’m not sure how people can say they're in compliance before they've even started their offering. Although in one sense that's the easiest time to say that you're in compliance, before you've actually done anything, since there's nothing to comply with at that point in time, but I doubt that the bill sponsors intend that result. In fact we know that there's going to be annual certifications that also require certification of compliance with securities laws. So this will certainly be a living requirement.
I can tell you as a securities lawyer how we immediately react to certifications of compliance with securities laws; it's very difficult to represent that you're in compliance with the securities laws because many of the laws are ambiguous.
Let me just take as an example of what's often dealt with in the EB5 arena. How much activity can a foreign migration agent have with respect to the US before it becomes subject to registration requirements under broker-dealer laws?
There's some very old guidance that the SEC put out which dates back to the late 1980’s and which they've recently and informally reiterated, but it doesn't tell you a lot. There's a lot of open questions.
Can agents visit the US for due diligence visits? A lot of people believe they can but we don't have any rule to point to that says that agents can visit the US for due diligence visits without triggering broker-dealer registration requirements. And what about other things the agents might do while present in the US?
That's just one of a long list of examples. Other ones that comes to mind are the Investment Company Act exemptions for funds with over 100 investors, as well as just general ambiguity in the disclosure standards under SEC Rule 10b-5.
As we've talked about in other webinars, there's not a lot of guidance on what needs to be disclosed in a private placement other than the general rule that you can't omit to state a material fact or be misleading when you do talk about material facts.
To put a requirement of certification, claiming that you and all of your agents are in compliance with the securities laws, is difficult. In one place in the bill, the certification is knowledge-based. I certainly think that that would be an improvement to apply throughout the bill, but even that is a requirement that makes securities lawyers nervous. It doesn't make us nervous because we don't think our clients are complying with the law but because these laws are so often ambiguous and require so much judgment that can be second-guessed with the benefit of hindsight.
Kurt Reuss: Ozzie, would you mind picking up on John’t comments. I know you have some strong feelings about the regional center’s responsibilities.
Ozzie Torres: I think that we should take the opportunity to step back and think about what this bill tries to do.
Of course it tries to do a lot and in trying to do a lot, there are many places where it is broad and ambiguous. That doesn't mean that its goal is not laudable from the perspective of trying to ensure that regional centers, to the extent possible, have some control over the NCE they permit to be within their economic zone.
A view is that the regional center designation, when granted, is essentially a license to conduct economic activity for purposes of the EB5 program. Now the question is, what responsibilities should a regional center have over the entities that it associates with it in order to enable them to take advantage of indirect job creation. I don't think it's unreasonable to impose some requirements. To the extent that the bill says it has to monitor compliance with all "laws, regulations and executive orders of the United States", where do we start being able to muster a regimen that an EB5 regional center can apply in order to ensure compliance?
There's so much detail needed in order to even make that possible that it's almost difficult to discuss it.