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SEC Rule 10b-5 and the scienter requirement

October 31, 2015

Panelists: ROBERT CORNISH, JOHN TISHLER, JOHN LEO,
Moderator: KURT REUSS

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John Tishler
w/ Sheppard Mullin

John Tishler: SEC Rule 10b-5 is what I’d call the primary rule of liability we’re concerned about in EB5 offerings. It applies to any offering of securities that has any jurisdictional nexus to the United States. Jurisdictional nexus simply means that some mode of interstate commerce was used: the telephone, an email, postal delivery. I think it is impossible to imagine an EB5 transaction taking place that did not somehow avail itself of the means of interstate commerce in the United States.

In any event, 10b-5 is going to apply and what it says is that it’s unlawful for any person in connection with the offer or sale of securities to omit or misstate a material fact or to state a fact that, in the context in which it is stated, is misleading and that’s considered to be a fraud. When people talk about securities fraud, Rule 10b-5 is what they’re referring to. 

In terms of the commonly used word “fraud” and the common sense understanding of it, lets discuss what it means to commit fraud. The standard for securities fraud is quite a bit lower than the common sense understanding of fraud. 

Fraud also includes an intent to omit a fact or to state a fact that wasn’t complete in its context. Rule 10b-5 has what’s called a “scienter requirement” in relation to the omission of facts which means there has to have been intent. 

The intent doesn’t have to be to rip an investor off or to steal from them. You just have to have the intent to omit a material fact. In many cases, the decision to omit something might not seem like a big deal at all. It’s only in hindsight, sometimes many years after the fact, when people are evaluating what actually went wrong.

If an investor either didn’t get his or her visa or didn’t get their money back then it would seem that that omission was significant. At that future point in time, Rule 10b-5 can be triggered even though no one could have imagined that what they were doing, saying or not saying was akin to committing fraud. They just didn’t think they needed to say something or maybe it didn’t even occur to them to say it, but that’s all it takes to trigger this liability under Rule 10b-5.

So what happens when you’re liable under Rule 10b-5? The remedies are damages—generally any damages that the investor can prove, and also a right of rescission, i.e. the right to get your money back. The 10b-5 remedy is available against anybody who was responsible for the misstatement or the omission.

The individuals who are making the disclosure decisions, the general partners of the issuers in EB5, can be personally liable under EB5. This is why securities lawyers get so wrapped up in all of this. If we miss something or if we say something that is misleading, potentially it can not only come back on the New Commercial Enterprise (NCE) but also on the individuals who were responsible for the disclosure document.

Kurt Reuss: I also want to mention to issuers that going to market with a Regulation S offering does not provide any exclusion from fraudulent activity.

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