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Consequences of Not Registering as an RIA

March 17, 2016

Panelists: LORI PATTERSON, CATHERINE DEBONO HOLMES, ROBERT CORNISH, CHRISTOPHER GABBARD

Moderator: KURT REUSS

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Lori Patterson
Baker Donelson

Catherine-DeBono-Holmes_120x150_BW

Catherine DeBono Holmes
JMBM

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Robert Cornish
Phillips Lytle

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Christopher Gabbard
Greenberg Traurig

Kurt: Chris, you mentioned to me that fines for not registering as a registered investment advisor can come in varying tiers, depending on the way you're perceived to have gone about not registering or the circumstances around it.

Fines can range from a lower level when the SEC recognizes that you're doing what you thought you should be doing, but you just didn't do it properly and fines will usually escalate for egregious and repetitive wrongdoings. Any thoughts on how the SEC perceives the issue of fines?

Chris: I think they're going to look at the activities you're actually conducting. In this case, with EB5 being a relatively new area, it's hard to say how they're going to go. I know the state of California structures their fines on a tier system.

Based on first offenses or minor offenses, it's almost a slap on the wrist, if you will. But I've also seen massive disgorgement of profits where some investment advisors have been operating two or three years without registering and they’re continually trying to skirt the rules.

In some cases they do this through the creation of additional companies in an effort to keep their amount under management spread out among multiple entities, but the SEC determines that those entities were integrated. I think it depends on the actual conduct that determines the severity of the fine.

Kurt: Lori, would you walk us through the importance of confirming an issuer’s registration status.

Lori: Regarding confirming your need to register (or not) as an investment advisor, I can't stress enough that you need competent securities counsel on this; someone who regularly deals with investment advisory registration who can advise you on the particular facts of your entity and your situation.

If you are designated, or if you think that you're going to be deemed an investment advisor, and you do register, then you've got a whole host of other tasks to accomplish, some we've already talked about, including having a chief compliance officer and having written supervisory procedures (which the SEC refers to as policies and procedures for investment advisors).

As to hiring a broker-dealer as a way to deal with investment advisor registration; I'm on the fence on this. I always say it's a good practice to hire a broker dealer if you are in the EB5 space doing these offerings. A broker dealer might be able to point out investment advisor rules and whether you need to register and, generally, where you might be lacking.

Having said that I do not think hiring a broker dealer is a substitute for registering as an investment advisor.

Kurt: Chris, what's your sense? Do you think a broker-dealer is a panacea for registering as an investment advisor?

Chris: I definitely do not think it's a substitute. There are going to be some instances where a broker dealer is incidental. They're going to fall under the exemption of incidental advice, meaning that it's incidental to their operation as a broker dealer.

Lori put it perfectly; its a good practice for a lot of clients in the EB5 space to, if not engage a broker dealer, have at least spoken with a broker dealer before they go live or begin using these projects.

Cathy: But it does raise an interesting issue. You can hire a broker dealer and say, "We're relying on the broker dealer so we don't have to be a registered broker dealer.”

But there's nothing in the law that says you can hire an investment advisor instead of getting registered as an investment advisor, which is an important difference.

Some people will say, "We don't want to register as an investment advisor but we think that maybe it offers a little bit of protection to us if we hire a registered investment advisor.”

They might say, ‘In addition to the fact that we don't have regular and continued supervisory authority over the assets of the fund, we also hired an investment advisor for the funds.'" Does that help? Maybe. I don't know. There's really no authority on it but I have seen people do it.

Lori: I would think another thing you could do is, if you have a person who is the control person or is doing a lot of the work, they could take the exam and become an investment advisor representative with the investment advisor you hired. That might be the bridge that you need.

Instead of a regional center or a general partner becoming an investment advisor that could possibly be a way to go about it.

Bob: I've got two thoughts on this from a risk management standpoint. If you're looking at preventing your general partner or your managing member of your fund from sales practice liability then using a broker dealer is probably a good idea.

That at least gives you the veneer of a presumption that you've got some entity that's actually engaging in the sales activity or supervising the sales activity rather than the advisor that's got enough work on his hands managing the fund.

The other thing is, if you are in the registration category here, you do have a lot of options available to you to facilitate your registration and ongoing supervision.

One of the things that firms regularly get in trouble for is delegating. In investment advisor registration, there are people who will attempt to delegate supervisory obligations. That is a no-no. The SEC has frowned on that repeatedly.

There are also some, what we'll call compliance-in-a-can outfits out there, that will purport to provide manuals, procedures, so on and so forth to help you get your registration done. There are several problems with that.

One, the SEC knows what those things look like. Two, they're probably not tailored to your specific business. Three, more often than not, firms get in trouble for having procedures and manuals they don't even follow.

It's very important to have your counsel talk to you specifically about the needs of your firm, the structure of your fund and the supervisory needs that your business model generates.

Cathy: I believe most regional centers and EB5 sponsors are probably going to do whatever they possibly can do to avoid registration as an investment advisor, unless they want to make it one of your primary businesses.

You're going to have to decide whether or not you want to take the exemption, whether or not you want to file Form ADV Part One or decide that you're not actually providing advice regarding securities.

One way or another, you want to do something so that you have thought through the issue and you have documentation in your files in case the question is ever asked as to why you've decided not to become a registered investment advisor.

Chris: The best thing for us to do is to get out in front of this given that the SEC is intent on making this a point of examination this year. Be proactive instead of reactive and have something to support the decision you ultimately make. If you haven't sought counsel on this issue, it's better to do it earlier rather than later.

Kurt: I will admit that we’ve never covered an EB5 topic that has been as complicated as this one. I think we're just scratching the surface today but I think you're all leaving with some information that will probably help you ask your attorney better questions.

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