The Integrity Act's Potential Impact on Regional Centers
Bob Ahrenholz offered the following questions regarding the Integrity Act of 2015:
"Section 1.3 of the Integrity Bill would require each regional center to supervise all offers and sales of securities. How does this impact broker dealer laws? Would this require regional centers to be registered as a broker dealer, if they do supervise sales of securities? What impact would this have on regional centers supervising foreign broker dealers? Same question regarding investment advisor supervision."
Greg: I think that goes back to my point that the ‘34 Act (Securities Exchange Act of 1934) laws are about broker dealers. I agree with Ronnie that we have to distinguish those provisions from the ‘33 Act (Securities Act of 1933) which is related to the sale of securities.
Those laws govern people who are defined as broker dealers, people who are affecting transactions in securities as a business. I think that if you look at the obligations being placed on the regional center they are being stuck with issuer liability.
I think we've all said that that is potentially questionable. They are also being given responsibilities that are very similar to the responsibilities that the broker dealer has to assure the integrity of the transaction. I don't think that that makes a regional center a broker dealer, however, because the ‘34 Act is unchanged.
The question is, is the EB5 regional center affecting transactions in the securities or is that being done by the issuer under the issuer exemption through a broker dealer or through migration agents, or however you want to look at that.
But that's why I say the regional center's getting stuck with broker dealer type responsibilities without any statement that they're going to be regulated by FINRA. They're not going to be regulated by FINRA unless they are actually obligated to register and I don't see an obligation to register under this act.
Ronnie: I agree with you completely. I don't see any obligation to register. I think it's just a liability issue for the regional center. I don't see how they're going to be deemed to be a broker.
Kurt: I think, Ronnie, Bob's point is that you're asking them to supervise. If you're supervising offers, then, obviously, you're putting them in a role that may require registration as a broker dealer.
Specifically, "Regional centers shall annually re-issue certifications stating the regional center has knowledge of the offers or EB5 investment advice, has complied with all securities laws and records and information related to offers have been maintained."
Ronnie, I know that agents and promoters and the current way that the industry is run is antithetical to some of the requirements that we see being put on regional centers in this bill. Do you want to talk a little bit about that?
Ronnie: First of all, I don't think it's appropriate, both legally and practically, to try and regulate what fees foreign agents charge. In conference calls, the SEC has said that they're not looking to regulate an off-shore sale under the 2008 regulations issued by the SEC for exempt foreign broker dealers.
I'd like to think that the industry would pay the freight for the changes imposed. If we think agents are making too much money, then don't use them or don't borrow the money at that rate, if you think it's too expensive.
By the way, there’s something really interesting at play here. As interest rates have gone down, there's a lot more pressure on agents not to be too greedy. I see it all the time, as I'm sure my cohorts also see the same thing. A developer will say, "Wait a minute. This is 5 or 6 percent. I can get it at 4% from the lender. Why am I doing this?" The answer is you're right. It makes no sense.
Kurt: I have a very different opinion on whether its appropriate. I think this is a tremendous opportunity for the EB5 industry, because if we have a regulation that says that all of the compensation has to be disclosed, that the description of the services have to be disclosed and the contact information of all of the agents and sub-agents has to be known, what happens is we suddenly start to get control of what we're not in control of right now.
That is, it feels sometimes like the tail is wagging the dog, that the Chinese agents are in control of this industry. I think it's difficult and dangerous for regional centers and issuers to live with that because at the end of the day its the issuers that will be held to task regarding compliance with securities laws.
Ronnie: Yes, but the proposed bill gives the Secretary the authority to regulate fees. I'm commenting on the fee charge. I'm not commenting on the ‘33 Act obligation. There's a difference between disclosure and regulating what somebody's going to make under the ‘34 Act for selling a security.
Michael: Reporting this information, well, there are already disclosure in EB 5 Visa requirements which the SEC has made crystal clear. The SEC was very clear that they want full disclosure about agent's fees made available to all investors.
I don't think the Integrity Act contains any language that purports to regulate how much fees agents can charge. That could be a next step, since once you open the door, people can walk through it. But at the moment, what the Act seems focused on is getting the identification of the agents and disclosure of the amount of their compensation.
Alone, those things track, I believe, existing securities law disclosure requirements. I don't think there's a new obligation being imposed there, although what is new under the Integrity Act is that it is being imposed on the regional center.
If the regional center has been making the payments, it will need to ask the issuer, "What are the disclosures you are making to satisfy the security laws in your offering documents," and to get the information that the regional center can use to report to USCIS under the new regime to be established under the Act.
It also appears in the latest version of the Integrity Act that USCIS is attempting to calm the industry by making it clear what USCIS is and is not going to do with the information about the overseas agents that USCIS is collecting in this way.
The information is not supposed to be made public, pronounces the Act. The information is apparently not supposed to be used by USCIS for making substantive decisions.
I think it's important to take that language at face value, because it shows a significant amount of progress over what was anticipated to be imposed on the industry in earlier versions of the legislation.
I do think there has been some definite progress made in improving the Act. I think that we might be hurting ourselves to attack provisions that we could still further improve by saying that they require something that they don't, yet, and that what we're really talking about is ensuring that those provisions of the Act be clarified and improved so they don't end up getting misinterpreted, misapplied, or taken to the next level and construed to require that there must be either registration or a fee-setting obligation that can be imposed by USCIS.
Personally, I wouldn't oppose a fee cap imposed by the SEC on U.S. EB-5 issuers, as far as the amount of compensation that those issuers could pay to overseas agents. Effectively, there is such a cap for domestic transactions, from FINRA.
Obviously, FINRA doesn't govern foreign agents active exclusively overseas, but there is a ceiling on the amount of compensation that a U.S.-registered broker can charge on a domestic deal. If that kind of an approach were applied to the EB5 industry, as far as a ceiling that was imposed on issuers as the payors of those fees (even though U.S. law cannot be imposed on the payees of those fees, the overseas brokers), that could have the effect of limiting the unprecedented and commercially objectionable increase in overseas agent fees that we've experienced over the last five or six years, and perhaps even rolling that back somewhat.
That would be a very good thing, I think, for the industry.
Kurt: I also think this Integrity Bill has tremendous opportunities for the industry and especially issuers.
There are a lot of obligations in here and I think, as somebody told me recently, the Rent-A-Center model is probably going to go the way of the dodo bird, but I think the best regional centers are going to be able to adjust to it.
One argument that I have heard is that the fees paid to agents makes EB5 deals uneconomical for issuers to pay their securities attorney to do the depth of work that a securities firm would typically do on a private placement offering. And the same arguement is made as to why the issuer can't afford to involve a broker dealer in the deal to supervise their solicitation activities. It often appears that EB5 deals are brought to market on a budget, which I believe exposes issuers to more risk then they are accounting for.
Our firm (EB5 Diligence) performs enough due diligence reviews to recognize that there is a lot of inherent risk in these deals. People are going to lose money if only because the economy doesn't perform as anticipated. There's likely to be investor lawsuits, whether they're reasonable or not.
But the fear I have is that investors aren't being explained the risks as clearly as they should, and that could come back on the issuer. In some cases investors are given the impression that there is no risk in these investments.
This bill provides an opportunity to take back control of the information that gets disseminated and ultimately, EB5 issuers need to build in the costs to get an offering in a condition that doesn't leave them vulnerable. This also includes D&O insurance and potentially E&O insurance.
When you're all said and done, building in the appropriate costs of getting of issuing a security enables issuers to know what they can offer agents.
But it will only happen when everyone has to do it. When all EB5 issuers follow the securities laws and have proper insurance in place, then whatever is left to make a deal work is going to be what the agents are going to take. If they try to take more, there's no deal to be made.
Greg: You're absolutely correct.
Ozzie: It really all starts with a good securities lawyer because if you have a good securities lawyer making sure that what needs to be disclosed is disclosed and over four years ago when I came in here I said, "You know what? These agent fees have to be disclosed."
Whether or not there is a precise rule that requires it, the bottom line I was told was, "We don't want to disclose it because we don't want the investors to know what we're making." I said, "That's precisely what makes it material."
I think we start there. Again, I'm not sure there's any real need for more laws. I think there are already effective laws on the record.
Kurt: I think the only problem with that Ozzie, is that the laws exist today yet this industry is still trying to navigate around arguments of "are we even in the securities business"? And the perception from many legislators is that the industry is filled with fraud, which its not.