Could Reg D 506(c) Offerings Replace Reg S Offerings in EB-5?
Kurt: We've had a number of webinars that discuss the potential problems issuers could face from a Regulation S offering, because of its strict rules associated to managing all solicitation and market conditioning to outside the U.S. and its territories. Contrast that to the Regulation D 506(c) rules which open up possibilities for a general solicitation to be conducted anywhere you want, so long as the issuer is committed to verifying each EB5 investor's accreditation credentials.
Three issues to consider when using concurrent Reg S and Reg D offerings are:
- Use separate documents for Reg S and concurrent Reg D Rule 506(c) offerings. That's integral to deciding to doing a concurrent offering.
- Don't use a website to solicit investors for Reg S offerings.
- Construct a separate web portal for each offering or else have a generic landing page that directs investors to appropriate content, tailored to each specific exemption.
My question is: What involvement is there in having a broker-dealer?
Scott Purcell: I'm not personally a broker-dealer though we own a broker-dealer; FundAmerica Technologies owns FundAmerica Securities, a wholly-owned subsidiary that does a lot of specialized cash management for escrow services and anti-money laundering checks that are compliant with the Bank Secrecy Act and Patriot Act, etc., so I'm very familiar with broker-dealers and their role in the back office.
Kurt: When I talked to NES, they pointed out to me that they are required to do their own source of funds investigation. As a broker-dealer, John Leo also does his own source of funds investigation of EB-5 investors as part of his FINRA requirement. Additionally the immigration attorney is doing a source of funds investigation for the I-526 petition.
So it appears that we actually have three groups independently doing source of funds verification.
Scott Purcell: It’s not just the source of funds but also anti-money laundering. All financial services firms, including broker-dealers and banks, are subject to the Bank Secrecy Act (BSA) audits, so they're subject to Treasury oversight as well as oversight by the SEC and other regulatory agencies. If a BSA subject firm does this check, then other firms are entitled, at their discretion, to rely on it.
If FundAmerica Securities or Primary Capital conducts these checks in anti-money laundering, then banks, developers and others can rely on that check. However, if a firm like NES, which is not a registered, regulated or overseen firm conducts it, nobody else can rely on their data. That's an important distinction.
Kurt: I know that your firm is a very big player in the technologies behind crowdfunding and I know that you're fairly new to EB-5. Can you talk a little bit about what services you offer to the 506(c) offerings and the costs associated with crowdfunding?
Scott Purcell: We offer back office technology transaction engines, plug-and-play invest-now buttons that people can put on their websites, as well as transfer agent services, escrow services, money movement, anti-money laundering checks, bad actor checks on issuers and associated persons, and a variety of other services.
Typically our fees are going to be around $500 to set up escrow, $25 a month for the account. For EB-5, it's $1,000 to set up, but instead of a percentage of the offering, we're just going to charge $50 per investor per month, very similar to NES' price schedule. For non-EB-5 project offerings, our services are going to run 1 to 1½ points of the offering.
Anti-money laundering checks from a domestic investor are $2 while on an international investor it's $5. Electronic document signature for transactions conducted online is $3.
There are just a variety of small fees associated with different tasks. Escrow accounting is $5 per investor as a one-time fee just to make the ledger entries, and things like that. Our fee schedules are online at FundAmerica.com.
The point is, it's a lot of small fees and it doesn't add up to very much money for the amount of work we do and the amount of automation we enable on an offering, so issuers can conduct it, be it domestic or offshore, with absolutely as minimal friction as possible, yet maximum compliance with regulations.
Kurt: The prices you quoted seem very reasonable and it seems there's a tremendous amount of value associated with getting an escrow service set up and getting your anti-money laundering check. What is the 1 or 1½ points for because that's obviously a bigger number? On a $500,000 investment in EB-5, at 1 point or 1% we're looking at $5,000 per investor.
Scott Purcell: On an EB-5 investment, our core technology fees and escrow fees are actually very minimal where you're talking about a setup fee of a couple thousand dollars and then $50 per investor per month. It's not going to add up. Where the 1 point comes in is if the issuer is not using a broker-dealer, like Primary Capital.
Our broker-dealer does not provide investment banking services or selling services, but it will execute transactions, so it will review investor trades or purchases that come in. It will review the data and ensure everything's done in compliance with regulations. It acts as the de facto broker-dealer selling to the investor for securities regulations if a broker-dealer is not already involved. That's an optional service that FundAmerica Securities offers for 1%.
You have these situations in the EB-5 space where people have not used a broker-dealer. They have not had a broker-dealer execute their transactions, and now the SEC is coming in and fining them because they've decided that the way they took compensation is incorrect. However, if they'd used a broker-dealer the SEC would feel that because a broker-dealer was involved, they can rely on the fact that the transactions were probably done in compliance and they're not going to chase it down.
Most of the problems happening in the EB-5 world that we are seeing with the SEC would not be happening if a broker-dealer was engaged, either to the extent that Primary Capital would be engaged, offering full service, or even as FundAmerica Securities is concerned, just executing the transactions.
Kurt: John, as a full service broker-dealer, what do you provide and can you give us a sense of the cost of it?
John Leo: If we’re engaged as a placement agent, we start with D&O questionnaires, background checks on the management, key employees, or anyone that has access to the money that's being raised. We do a site visit, we do interviews with the developer, the promoter of the project, the EB5 regional center. We request and review information from the regional center, the EB-5 project itself. We look at the construction timelines, the exit strategy, the financial model, we make sure that all the documents required by USCIS have been provided.
It's a pretty broad background in terms of due diligence. We typically get a PPM that's close to a final draft or a final version. We review it along with our counsel and provide comments and edits and send it back to the issuer. Those are typically comments and edits that protect the issuer as well as ourselves.
We also review the marketing materials. I've found in the past that the SEC catches a lot of errors or omissions in marketing materials from the statements that are made that aren't in line with the PPM. Before they go out, we require that issuers' counsel sign off on them, and that's something that is unique to EB-5.
Two or three years ago, when we first got into the space, no one was really having their counsel review any marketing materials. It would go off to China and whatever they did with it over there was done. Our position is that the issuer needs to control those marketing materials and control the content and sign off on any changes as if it's the PPM.
Once the transaction is closed, the admin fee's been paid, the investment fee's been paid, and all the documents have been sent back to the issuer. The issuer would then accept them, presuming that all the documents are approved, but prior to accepting them as a limited partner or as a shareholder, we review everything. We would contact the investor directly and ask if they got a PPM.
A common question that FINRA asks us or that the SEC would ask an issuer is can you prove that the investor got a PPM. You can provide the document that shows they say they got it, they signed that they got it, but that's not good enough for the SEC or FINRA. You have to prove that they got it. They want to know was it downloaded from a website? Was it handed to them by an agent - which is most likely the case in China?
If it was hand-delivered, we would typically request that the issuer resend them a link so we can capture that they downloaded it. In most cases, some of the information is incorrect - some percentage of Reg S investors are really Reg D investors in the deal, so we go through all that.
Then we create a due diligence file so in the event there is an audit, we have it available for review.
Kurt: What do you charge for your service?
John Leo: We charge an upfront retainer fee of $30,000. That covers the upfront due diligence, the site visit, the travel time, whatever is involved in that. We do an internal report that is a representation of all our due diligence with an internal discussion and analysis of the project.
If the project were to be audited, the audit team could just pick that folder out and see, "Okay, this banker did this site visit on such and such a date. This background check was done on such and such a date." We essentially memorialize the project's due diligence process.
We charge a per-investor fee on the back end from the administrative fee.
It depends on the size of the deal, but in general terms, if the deal is, say, between zero and $50 million, we charge $2,000 per investor. If it's $50 million to $100 million, we charge $1,800 per investor. If it's over $100 million, we'll charge $1,600 per investor.
Usually we expect to get that fee upon the investor being accepted as a shareholder or a limited partner into the new commercial enterprise. In some cases, we'll take it when the I-526 is filed. That depends on the deal and how the PPM is drafted.
Kurt: Jor, regarding your website, VerifyInvestor.com, what exactly is being verified in terms of being accredited?
Jor Law: It's purely whether they are accredited investors per the SEC’s definition. The SEC actually provided safe harbor guidance on how to do it. For income, for an American person it would be some sort of tax documentation, W-2, 1099, K-1. For foreigners, it would ideally be their country's equivalent, and if their country's equivalent doesn't have something like that, then our reviewers would have to get an employer’s letter confirming their income.
On the net worth side, the SEC guidelines say we need a consumer credit report, a statement of liabilities or that there are no liabilities, and then evidence of the assets. For international folks, of course, if there is a country equivalent of a consumer credit report, they should provide it. If not, then they can certify that there's no credit report, but they still have to give a statement as to their liabilities and then a statement as to their assets along with supporting evidence. Fortunately, in many other countries, a lot of the investors that are looking to go EB5 process have very little debt, if any, and many of them are quite asset-rich.