Disadvantages of Hiring a Broker-Dealer for an EB-5 Offering
Kurt Reuss (host): What are some of the disadvantages, or even competitive disadvantages, of hiring a broker dealer as a placement agent for an EB5 project offering?
Jackie Prester: Before tackling the question, I'd like to just take 15 seconds to remind folks what the 'competitive advantages' of hiring a broker-dealer 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 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 EB5 investors. I see those as some of the competitive advantages.
The key competitive disadvantage that I see from using a licensed broker dealer is the additional regulation. For example, broker dealers have to deal with FINRA rules on the disclosure of compensation that is paid to foreign finders. Issuers must go through particular steps in terms of compensating migration agents when a licensed broker dealer is involved.
As an issuer you 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 offering.
Michael Homeier: Certainly, there's an additional cost to including a broker dealer, as everyone can guess, there's going to be a fee. Jackie touched upon what we think of as the primary disadvantage, but there is an additional disadvantage which has to do with ambiguity regarding the due diligence process.
Requirements of USA investor visa brokers who conduct due diligence reviews under the FINRA requirement do so to assure themselves that the security can be appropriately offered to a class of prospective investors, in this case EB-5 investors. The broker’s due diligence review can be far less stringent than an independent, third party due diligence review.
Kurt, forgive me for plugging your company EB5 Diligence, but EB5 Diligence conducts 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 linked with EB 5 Visa projects.
EB5 Diligence is a third party that gives 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 that meet its FINRA obligations.
It's not particularly helpful for an issuer to offer potential investors the broker's internal due diligence report as if it were an independent third party due diligence report (which it is not). Remember, the broker is an agent of the issuer - the issuer’s salesman, and the broker’s due diligence review is 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, nor is it as independent as the issuer may be representing it to be.
So, issuers need to acknowledge what kind of due diligence report are they getting, and from whom, and what they are going to use it for. If the issuer thinks providing a due diligence report is going to be helping their 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 to potential investors.
Robert Cornish: FINRA Rule 2111 is the operative rule. Broker-dealers have to make what's called a “reasonable basis” suitability determination which 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 terms of making a recommendation to an investor. 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 related to the investor's EB5 capital. 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: I have yet to hear a compelling reason why an issuer shouldn’t hire a broker dealer, 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 or even having their fees disclosed to investors, which regardless of whether you are using a broker dealer or not, you must do.
Don’t you think that avoiding these issues in order to attract Chinese agents is why some of the issuers are choosing to bypass hiring a broker dealer?
Michael: 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 EB5 investment regulations. So when you're out there in the field presenting to individuals, be sure you are complying with U.S. laws.
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. The investors like that rules are in place in the U.S. You should think really long and hard about that.
And 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 an EB5 regional center, using a broker dealer is probably the best thing you could do in terms of shifting many supervisory obligations. You still have obligations, but the broker-dealer will get you to a place where you're managing your project rather than managing your sales efforts.