Federal statutes against EB5 investments
(Steven Kramer): Developers seeking to raise capital by forming (or otherwise utilizing) an EB-5 Regional to sell investment securities to foreign nationals face potential claims under the U.S. and state securities laws. Here we focus on federal securities claims and the various Statutes of Limitations that apply.
Statutes of limitations set the time period during which a government enforcement or private action must be brought. If not brought before the expiration of the relevant limitations period, a developer who is a defendant in an enforcement proceeding or private claim based on securities laws can assert the statute of limitations as an affirmative defense potentially resulting in dismissal of the claim.
Statutes of limitations promote justice by preventing the assertion of claims after memories have faded and witnesses and documents are no longer available.
A number of federal statutes potentially serve as the basis for a claim against a developer raising capital from an EB-5 investment offering. The limitations periods under these statutes vary and often depend on who is bringing the claim and the penalty or remedy that is sought.
Full disclosure in the PPM
Before going into the specific statutes of limitations, it is important to emphasize that everything possible should be done to make sure that your PPM makes full disclosure and that there are no misstatements or omissions of fact. If full disclosure is made, you will not have to worry about the statute of limitations because the chances of a lawsuit will be greatly reduced. The statute of limitations is an affirmative defense that your lawyer could raise in a case claiming that a lawsuit was not brought in a timely fashion.
Federal Securities Laws
EB-5 business plan must work in compliance to Federal securities law that addresses private litigation actions brought by an investor and SEC enforcement actions. A private investor who purchased an EB-5 security could bring an individual action or a class action in federal court under federal securities laws (and state securities laws or common law) and if the money was misused or misappropriated, the Justice Department could bring a criminal case (or the district attorney's office or the attorney general's office of a particular state) could bring a criminal action.
Here we will address provisions of two federal securities laws;
- the Securities Act of 1933 (the "Securities Act") which deals primarily with the registration and sale of securities, including PPMs.
- the Securities Exchange Act of 1934 (the "Exchange Act") which deals with the aftermarket purchase and sale of securities as well as proxy statement, public company filings and other activities.
Section 12 of the Securities Act
Section 12 authorizes an EB-5 investor (securities purchaser) to bring a private civil action to rescind the purchase if the seller uses a materially false or misleading prospectus or makes materially false or misleading oral statements in connection with the sale.
The investor must bring the rescission action within one year after the discovery of the untrue statement or omission, or within one year after such discovery should have been made by the exercise of due diligence, but in no event more than three years from the relevant sale.
Section 17(a) of the Securities Act
Section 17(a) is the Securities Act’s anti-fraud statute governing all securities sales. It prohibits the use of schemes to defraud and misstatements and omissions of material facts and is the mirror image of Section 10(b) and Rule 10(b)5 Exchange Act.
With regard to a private cause of action under 17(a) by an investor, there is a consensus among the various circuit courts, including the 9th and 2nd Circuits, that there is 'no private right' of action under Section 17, but the SEC may bring an enforcement action under Section 17.
To the extent the SEC brings an enforcement action and seeks to impose a “fine, penalty, or forfeiture,” it must commence its enforcement action “within 5 years from the date when the claim first accrued.” A claim “first accrue[s]” under 28 U.S.C. § 2462 when the SEC’s right to enforce comes into existence, not when the SEC actually discovers it. Thus 5 years is the outer time limit for any SEC claim seeking to impose a civil penalty on a developer.
To the extent the SEC’s claim seeks disgorgement of the proceeds obtained from the sale, or injunctive relief to stop further violation of the Securities Act, the SEC takes the position that the 5 years limitations period does not apply.
Gabelli v. SEC
In Gabelli, the SEC brought an enforcement action seeking civil monetary penalties from defendant. The complaint alleged the defendants aided and abetted fraud in violation of the Investment Advisors Act. The alleged actionable ended in August 2002. The SEC, however, only first discovered the scheme in 2008, commencing its action in April 2008.
To avoid Section 2462’s 5-year limitations period, the SEC argued that a “discovery rule” should apply such that its claim only accrued when it actually discovered the fraud or, with reasonable due diligence, should have discovered the fraud. The Supreme Court rejected the argument and held that the SEC’s claim, to the extent it sought monetary penalties, was time-barred by Section 2462.
The Supreme Court did not consider and so held open the possibility that the running of the statute of limitations might be equitably tolled if a defendant takes affirmative steps to conceal its wrongdoing.
Rule 10b-5 of the Exchange Act
Rule 10b-5 regulates all purchases and sales of securities which strongly guide EB-5 compliance. It prohibits among other things, schemes to defraud, material misstatements and omissions.
A private civil claim brought under Rule 10b-5 must be filed within two years after the discovery of facts constituting the violation (or when a reasonably diligent plaintiff would have discovered such facts), or within five years after such violation, whichever comes first. The five years from the date of the sale is a “Statute of Repose”, the outer-limit that begins to run at the time of the violation.
To the extent the SEC seeks to impose a “fine, penalty, or forfeiture,” it must commence its enforcement action “within 5 years from the date when the claim first accrued.” No discovery rule applies to the SEC but the SEC takes the position that no limitations period applies to an action seeking disgorgement or injunctive relief.
Section 15(a) of the Exchange Act
Section 15(a) prohibits persons from acting as brokers or dealers in the promotion of EB-5 investments (sale of securities) unless registered as a broker-dealer. A third party who receives any transaction-based compensation in connection with an EB-5 investment (securities transaction) is often deemed by the SEC to be acting as a broker-dealer. The use of an unregistered broker-dealer to raise EB-5 capital could subject the developer to potential liability as a “control person” or as an aider and abettor of a securities law violation under Section 20(a) and 20(e) of the Exchange Act.
SEC enforcement of civil monetary penalties must commence within 5 years from the date when the claim first accrued. No discovery rule applies however, as with other SEC enforcement actions, the SEC takes the position that no limitations period apply to actions seeking disgorgement or injunctive relief.
Courts generally hold that there is no private right of action for violations of Section 15 of the Exchange Act but note that some state laws may allow a rescission claim against the issuer when the issuer knowingly uses an unregistered broker-dealer to effect the transaction under the purview of EB-5 process.