What are some of the competitive disadvantages of hiring a broker dealer as a placement agent for an EB-5 offering?
Jackie Prester: Before tackling the question, I'd like to just take 15 seconds to remind folks what the 'competitive advantages' are, and then we can pile on the disadvantages. In terms of the competitive advantage of having a broker dealer, I think there's something to be said from an investor's viewpoint of knowing that a broker dealer has gone to the trouble of doing the due diligence necessary to serve in this role. There's a certain credibility factor that gets added for that issuer.
There's also a competitive benefit to the issuer when a broker dealer is involved. A broker dealer is in the business of putting together the disclosure documents and pulling together a lot of other materials, of running the time-line.
A broker-dealer has the expertise to help the deal go more smoothly and to make sure it will be marketed in a way that is appealing to investors. I see those as some of the competitive advantages.
The key competitive disadvantage that I see with using a licensed broker dealer is the additional regulation. For example, broker dealers have to deal with the FINRA rule on the compensation that can be given to foreign finders. Issuers must use a particular set of disclosures and go through particular steps in terms of compensating migration agents when a licensed broker dealer is involved. As an issuer you just don't have to pay attention to those rules because you're not subject to FINRA. That's the biggest 'competitive disadvantage' to me. It’s the additional regulation that goes into the whole process when you have a licensed broker dealer involved in the mix.
Michael Homeier: Certainly, there's also additional cost to including a broker dealer. As everyone could guess, there's going to be a fee to be paid. I think Jackie has touched upon what we think of as the primary disadvantage. But there is an additional disadvantage, and it has to do with ambiguity with regard to the due diligence process.
Brokers who conduct internal due diligence reviews under the FINRA requirement do so to assure themselves that the particular security can be appropriately offered to a particular class of prospective investors. The broker’s due diligence review is far less stringent than an independent, third party due diligence review.
Kurt, forgive me for plugging your company EB5 Diligence, but EB5 Diligence does these independent, third party reviews of offerings, and it's a very thorough review. We have worked with that company, your company, on a number of transactions. Those reports are heavily relied upon by investors -- although there is an issue around who pays a company like EB5 Diligence for that due diligence report.
EB5 Diligence is a third party, and it is going to give its straight opinion in detail about all sorts of aspects of the offering and the investment opportunity. That can be and often is far greater in detail than the due diligence review that a broker does internally in satisfying itself that the particular offering is one that the broker can participate in and meet its FINRA obligations.
It's not particularly helpful for an issuer to offer to provide the broker's internal due diligence report as if it were an independent third party due diligence report (which it is not) and share it with prospective investors. Remember, the broker is an agent of the issuer, and, if you will, is “the issuer's guy.” The broker's the issuer’s salesman, and the broker’s due diligence review is, again, not as thorough in many cases as an independent due diligence review that would be prepared not for internal use, but instead to be given to investors.
An issuer who proposes to provide the broker’s internal report is actually hurting itself because the information in such a report is not as thorough as an issuer may be representing it to be, and not as independent as the issuer may be representing it to be. So, issuers need to know what kind of due diligence report are they getting, from whom, and what are they going to use it for. If the issuer thinks providing a due diligence report is going to be helping the marketing effort, the issuer needs to make certain that it is the third party report rather than the broker's internal due diligence report that is provided.
Robert Cornish: I'd like to chime in on that whole suitability issue. FINRA Rule 2111 is the operative rule. Broker-dealers have to make what's called a “reasonable basis” suitability determination, and that means that the FINRA member has to have a reasonable basis to believe that the product is suitable for at least somebody. That does not, however, necessarily entail “everybody.”
FINRA Rule 2111 is not to be confused with customer specific suitability obligations, which are what an individual placement agent has to deal with in term of making a recommendation to an investor saying “this is something you should do.” I think all of us here recognize the tension that occurs between an individual placement agent out in the field somehow relying on a broker dealer's own due diligence. It's questionable whether that agent can really rely on the broker-dealer’s evaluation when they're talking to a specific investor. That individual has to make their own determination and evaluation of the offering. In fact, your PPM and subscription documents should specifically refer to the investors’ own independent evaluation of the offering.
In terms of what is an advantage or disadvantage, you want to recognize that the placement agent (broker-dealer) certainly has a burden that places them in the cross hairs of regulation with the investors, primarily due to FINRA Rule 2111.
Kurt Reuss: Looking at our poll today, just 20% of the issuers attending responded, "Yes, I will use a broker dealer.”, approximately 20% are said “No I'm not likely to use a broker-dealer” and 60% are on the fence right now.
I have yet to hear a compelling reason why an issuer wouldn’t hire one. So let me put this out there. Chinese agents to some degree are resistant to having a broker dealer involved. They don't like sharing their fees and they don't like having to disclose those fees. Don’t you think that is why some of the issuers are choosing to bypass hiring a broker dealer?
Michael Homeier: I'll just put it this way. If you're not being regulated, the regulators will show up to make sure that you are. The question really comes down to whether you want to put forth the effort now to comply with the law and comply with the regulations. So when you're out there in the field presenting to individuals, you are complying with U.S. law.
Remember, we're dealing with people who are generally coming to the United States where we follow the rule of law. There's a certain schism when we say, "maybe we should just disregard it when we're trying to get these people to come to the United States."/ They want rules in place. You should think really long and hard about that. But mark my word, you can go about your business and think that you're not subject to these rules, but you are. And the question really becomes do you want to comply or not.
Frankly, if you're an issuer or a regional center, using a broker dealer is probably the best thing you could do in terms of shifting a lot of those supervisory obligations. You still have obligations, don't get me wrong, but the broker-dealer will get you to a place where you're managing your project rather than managing your sales effort.