By: Kurt Reuss on March 13th, 2015
Sources of Guidance re: Disclosures
When dealing with EB-5 offerings, we’re dealing with private placements that are universally intended to be exempt from regulation under Regulation S or Regulation D, with one small exception. In the Regulation D context we don't have any defined information requirements in the SEC rules. And the one small exemption is that if you were to do a Regulation D offering to unaccredited investors then there are extensive information requirements that must be in your offering documents. For that reason, almost nobody deliberately conducts a Regulation D offering to unaccredited investors.
So as a practical matter we're dealing with a situation where none of the rules I’m about to discuss literally apply to EB-5 offerings. So why are we talking about them?
Well we're talking about them because the standard that does apply -- Rule 10b-5 -- is so vague. It's very hard to deal with just broad platitudes about what's right and wrong. It’s much easier to look for some other place for guidance, say in some other context, when people are doing something similar to this. Here are some rules that have been around for a while that you can look to as guidelines and which might identify information that is material.
Regulation S-K is a set of regulations that defines what public companies have to disclose in various documents they file with the SEC and the Items are items in Regulation S-K.
Item 101(c)(iv): requires disclosure about the importance of franchises and concessions that are held by the business. A hotel might have a flag, so if it’s a Marriott hotel, what is the nature of that concession and what is the nature of the developer’s or operator’s ability to call this hotel a Marriott and what are the conditions of the franchise agreement that the developer and operator have to meet in order to continue to call this hotel a Marriott?
Item 101(c)(vii) requires disclosure about dependence on a single customer or a few customers. If the nature of the business is that it is going to have a concentration of customers, a public company has to disclose who those customers are and its dependencies on them. And probably also the nature of the relationship; for example, “are they locked in”? “Do you have a guaranteed supply agreement with that customer”? “Can they walk away at any moment”?
Item 101(c)(xii) requires public companies to make extensive disclosure about the material effects of compliance with environmental laws.
Of course EB-5 being so heavily concentrated in real estate, depending on the particular projects we're talking about, there may need to be a risk factor to the effect of "Who knows what tanks might be buried under the ground that even though we did our phase 1 or phase 2 study we might not know what’s there".
You could have that kind of general disclosure but there may some very specific disclosure about specific environmental problems that you know about and what you plan to do about them.
Item 102: is a description of real properties that you hold. EB-5 being so real estate dependent, this item suggests extensive disclosure about the nature of the real property.
Item 404: ‘conflicts of interest’. EB-5 deals tend to have conflicts of interest. There are fairly elaborate standards for public companies about what does and doesn't have to be disclosed for conflicting interest transactions.
Rule 503(c): risk factors. All EB-5 offerings have risk factors and I don't know that there is really a lot of guidance to Rule 503(c) as to what the risk factors should be. However, you can get a lot of guidance about risk factors from looking at public company SEC filings. Every public company in existence has a long list of risk factors and reviewing publicly available risk factors for a business comparable to the JCE’s business serves as a good checklist about some of the risks that might be in that business.
The last thing I’ll mention is Regulation A. Regulation A is a longer conversation apart from this webinar but potentially becomes useful in the EB-5 world because a revised Regulation A under the JOBS Act is on the horizon. [Editor’s note: Final rules implementing the JOBS Act requirements for Regulation A were adopted by the SEC after this webinar was recorded, and become effective June 19, 2015.] As we sit here today Regulation A is virtually never used by anybody for anything. The reason we’re discussing it is that Regulation A has a question and answer form disclosure document that is submitted to the SEC.
If you’re selling to an unaccredited investor, Regulation D actually references the Regulation A disclosure document. The Regulation A disclosure form is a pretty helpful document that asks questions that help when we’re working on PPM’s. We want to make sure we’re asking all these questions of our clients and making sure that to the extent the answers are applicable, that we’re putting appropriate disclosures in the PPM.
So, this is just a kind of helpful list of where to go for some specifics because the general principles can be hard to apply and practice.