Kurt Reuss: John, as a broker dealer in EB5, what about the argument that you probably don’t have the ability to raise money for an offering right now.
John Leo: I would agree. Last year, we probably brought 30 investors into deals but to get these deals done you really have to go through China. That’s simply how this business is currently designed.
Kurt Reuss: What is the role of a broker dealer and how do they provide compliance? And where in the process does that compliance sometimes fall apart? Are there situations where an issuer doesn’t get the compliance or coverage that they thought they were going to get and that they’re paying for?
John Leo: Certainly, I guess there are a number of ways to frame it. If you hire an immigration attorney, they’ll do their job as an immigration attorney. If you hire a securities attorney, they’ll draft the documents. The fact is we reject more than half the deals we see. Probably 9 out of 10 of the deals we see in this space, we reject. If you can recall the recent issue of fraud in Seattle, we would not have done that deal.
One person controlling every aspect of a deal, that’s a pass, a complete pass. The fact that a deal’s getting done, that it has a securities attorney and an immigration attorney doesn’t necessarily mean it’s a good deal or a bad deal. It might mean that no one has really dug into the transaction from the investor’s perspective. Ultimately, that’s the job of a broker dealer. As a service provider, you never want to be associated with a fraud or a failure in any business and EB5 is a small business so certainly, you wouldn’t want to be associated with that.
We would require an administrator; someone in the middle. Our job is typically not done when the transactions close and there are generally lots of transactions. But if there is only one person who controls the regional center, and he’s both the issuer and the developer, then that’s a recipe for disaster. Not just in this business but really in any type of financial transaction.
Kurt Reuss: How do you deal with an issuer who wants to raise money in China but you’re forced to deal with agents who control the marketing materials? They control the discussion more so than normal private placement business would allow. How do you help an issuer in that situation?
John Leo: I do see the industry moving further upstream. We were recently engaged by two agents to represent them. Ultimately the money controls the transaction so I do see agents and they look at this recent fraud transaction. They raised over $200 million, those assets are frozen so maybe more than half, 70%, even 80% of their compensation is now frozen. If they were getting points on the back end, they’re out. They’re not getting that money.
When they take a hit financially, they’re quick to change their view on compliance. But I think that applies to everybody—the investor, the issuer, the agents. I do see the business changing in that our client is currently the issuer but ultimately our client will likely be the issuer and the agent raising the money.
In terms of value added, we push to get these things done but ultimately there are certain transactions and certain aspects of transactions that don’t go in the direction they really should. I’ve seen a transaction where the issuer was taking money out of escrow prior to hitting their minimum. Essentially, they were taking money, compensation, without actually selling anything. And that was a PPM that came to us through a securities attorney who reviewed it and signed off on it. There were other issues in the transaction, which we addressed.
We look at it from the point of view that we have the most liability. In the event there’s a fraud or there’s a problem, the first stop is the broker dealer. The SEC and FINRA are both going to send us a request list, or we’re going to be required to go to an “On The Record” (OTR) interview. The SEC or FINRA is going to show up at our office so we have the most liability and the most to lose, in my opinion.
It’s pretty simple; one transaction can take down a broker dealer. I’ve seen broker dealers taken down for all different types of reasons but a $20, $30 million fraud, if we’re in the middle of it and we didn’t do our job, then that’s a big problem. I think given the liability that we potentially have in a deal, you bet we’ll push to get things done and we’ll push the management to add a fund administrator. If they are the developer, as well as the issuer, well that’s a clear conflict of interest; we wouldn’t do the deal. We would require someone in the middle for the draw downs that are required. We would require someone else on the bank account.
Honestly, in most of the deals, the issuers don’t want to do them, so we don’t do the deals. But if they’re getting the deals done elsewhere, it hurts the entire industry. As a service provider, whether an economist, a business plan writer, or what have you, it’s important that those weaknesses are pointed out as opposed to getting on board. If you’re a good securities attorney or a good immigration attorney, it’s almost guaranteed; you bring credibility but to someone who may not deserve it. That’s how I look at it, anyway. I don’t want to lose credibility and I think taking that approach as a group, we can certainly vet bad transactions by not providing a service.
Kurt Reuss: Bob, do you have any thoughts?
Bob Cornish: Yeah, clearly the very nature of EB5 products makes marketing material issues more difficult to handle from the broker dealer standpoint and the issuer standpoint. Some things within the EB5 industry haven’t yet caught up. One thing in particular that we haven’t discussed is the use of audited performance.
A lot of the work I do is with institutional money management firms. For the most part, these firms, in order to represent past performance in marketing materials, they will engage in what’s called a GIPS audit. That’s the Global Investment Performance Standards which is a convention that’s accepted worldwide and utilized to measure the performance of portfolios or an investment management firm.
You get to say what’s part of one strategy, what’s part of another, how do you measure things, how do you measure fees? Are you measuring performance growth of fees, net of fees, all that kind of thing? That sort of auditing, which is usually done by a GIPS auditor, is used by the institutional investment community to protect themselves in the event of issues regarding their marketing material. But as we said, the inconsistency of marketing material from a PPM is something you really, really need to be aware of.