The Evolving Role of Broker Dealers in EB-5
Kurt: How do you see the role of the broker dealer evolving as regional centers are required to provide certifications of securities compliance as stipulated in the draft Integrity Bill?
Greg: I'm not yet ready to concede that EB5 regional centers have to be broker dealers but it's all based on what activities they're engaged in. You certainly can't use a broker dealer as a shield, if either the issuer or the regional center is going to engage in unlicensed broker dealer activity, but I think we're going to see more broker-dealers in the space.
Ronnie: Right now, a substantial majority, and I'm guessing over 90% of EB5 capital, is not raised through broker dealers. I could be wrong but that's my perception. That's not good or bad, it's just the reality.
I don't think we're trying to change the industry but we want to strengthen compliance with certain procedures, in particular the ‘33 Act (Securities Act of 1933) with disclosures. I think everybody agrees that we need to make sure there's proper disclosures.
Whoever the issuer is, and the principal to the issuer, needs to take responsibility for complying with many of the items in the proposed Integrity Bill. Now the question becomes, do we impose that responsibility on regional centers, if they are not the issuer?
I don't know if we could impose a broker dealer requirement on an industry which, right now, is not based upon a broker dealer compliance standard. Now, I have no personal objection to broker dealer involvement, but I surely wouldn't want to use that as the given model in every case.
It's good in some cases where you're doing US marketing, but the traditional model includes going to China or other countries in the world and dealing with off-shore agents. We need to come to grips with what type of information from the ’33 Act needs to be in the offering documents.
I think that's one set of issues. Who's doing the diligence? You've already got the ‘33 Act (Securities Act of 1933) with a well established standard regarding offerings, i.e. disclosures and due diligence which has been present for a long time. There are plenty of rules, regulations, lawsuits and cases on this. I don't think we're trying to change that.
EB5 is a very weird duck because it's not like a typical promoter who wants to raise money to do a real estate deal. Here you've got an NCE that's lending the money to the developer. Who's the promoter? We've got to carefully figure out who's playing what role in the process. If the developer sets up the NCE and is acting as the manager of the NCE, then it is the promoter.
If the developer just receives a loan from a group that raises money and sets up NCEs, then it should not be the promoter. We need to define who is taking what role in the process.
Kurt: Obviously there’s a lot to cover in this Integrity Bill but maybe the first thing we need to do is to understand what the directions are because there are securities laws that exist today that should cover everything. If the government felt that the securities laws were working, then I don't think we would have the Integrity Bill.
My sense is that the government doesn’t think they're working. They seem to be looking to provide another layer of responsibility here.
Mike, on this issue of involving a broker dealer in the EB-5 offering, the firm that I work with has a service where they just offer EB-5 compliance to issuers and regional centers. Their role is specifically to review the offering from an investor's perspective, perform due diligence (legal and transactional), provide the issuer with policies and procedures to follow and manage the investor intake process.
What's your feeling about bringing a broker dealer into a deal given the way you see this Integrity Bill going?
Michael: Certainly I can agree with Ronnie's point on brokers, but we think it's helpful to acknowledge every single EB5 project using overseas agents are already using brokers. Those foreign agents are brokers under the definition of that term provided in the U.S. securities laws. They may also perform additional non-broker functions, but in sourcing investors and selling to them U.S. EB5 investment opportunities, they are certainly performing the salesman function of a broker.
Now, they are of course foreign (non-U.S.) brokers. Therefore, on account of their activities overseas, they don't need to be registered with FINRA or SEC. They should not have activities inside the United States, because if they do, that raises what the SEC call "registration issues" on account of those activities.
People look at EB5 projects that don't have a US-registered broker-dealer involved, and consider those projects as not involving a broker. But, that's an incorrect blanket statement. In fact, all of those foreign agents who are selling the deal in their home countries are, in fact, brokers, so more correctly, the project has foreign brokers, just not U.S. registered brokers.
The idea of engaging someone to help sell an EB5 offering is not a novel concept. In fact, the vast majority of EB5 projects are already doing it. They're just not hiring Americans or foreign persons who are active in the United States.
With that in mind then, I think it becomes important for everyone to ask, "Why go to the additional trouble and expense of adding a U.S. broker to the mix, if a U.S. broker is not a requirement in order to sell the offering overseas?"
Our opinion is that it is advisable, even if not required, because the participation of a U.S. registered broker brings many advantages to the endeavour. Those advantages, while they don't rise to the level of meeting a legal requirement, are real, tangible, practical benefits that we believe outweigh the costs of engaging yet another professional, this one who doesn't technically have to be involved.
The advantages that the U.S. broker brings are multiple. They include the additional scrutiny that a U.S. broker performs, and the fact that, in fulfilling its role as FINRA regulations require, it has to make sure that the investment is “suitable,” one that is appropriate as an EB5 investment broadly, and also one that is appropriate for particular EB5 investors to participate in.
The U.S. broker also acts as an additional pair of eyes to oversee the offering materials and weigh in on whether or not those materials are consistent among the various documents, (inconsistencies can be very dangerous), or whether there are important or vital disclosures that either aren't being made at all, or are being made in an unclear way, which also could result in dangerous consequences if they cloud or obviate entirely a critical disclosure.
There are a host of advantages that can accrue to taking the not-legally-required act of engaging a U.S. broker to enhance a U.S. offering being conducted overseas through the EB5 Program. That's why we encourage clients to make room in their budgets for including a U.S. broker.
Ronnie: I’d like to add something, if I may. Michael, those are all excellent points. I think the issue about the migration brokers may also be that they are licensed abroad to engage in whatever activity they engage in but they're not necessarily licensed to deal with securities.
Secondly, you probably would need a broker in the case where an issuer and its principals are doing more than one offering a year, and then they may not be included in the safe-harbor provisions under the issuer exemption.
Greg: I agree that Michael made a number of very good points. I guess I would say, after hearing your description of the benefits of brokers in securities transactions, which I don't disagree with at all, that they up the level of the whole game.
If one looks closer at this Integrity Bill, a lot of what the bill is seeking to do, in my opinion, is exactly because the model does not now include brokers.
What it seems to be intending to do is say, "We want to impose obligations on regional centers that are similar to the obligations that are placed on brokers, to do due diligence, to make sure that the offering documents are legitimate, to make sure that the laws aren't being violated, et cetera.
Brokers don't necessarily take on issuer liability. They can have liabilities associated with the offering but they're regulated by FINRA. They're required to do all those beneficial things that Michael mentioned.
This bill is essentially saying, "If you don't include brokers in the industry, then we're going to make EB5 regional centers act like brokers. We're going to attempt to make them do the types of things that brokers do to obtain information, keep records, make sure there are no violations, make sure there's diligence.”
If you really look at it, they're trying to set up a little mini-FINRA model.
Going back to what I think Ozzie was saying is whether it`s wise to have that scheme? Maybe it is, if the industry isn't going to include brokers. I think that's the intention that I see.
Picking up on the point about what migration agents actually do, my understanding is they do have a license to do certain educational things.
I don't know Chinese law. I don't know whether that does or doesn't extend to securities. In my understanding, it doesn't, but I think part of the argument they could make is that the migration agents fulfill an educational role that's sanctioned by the Chinese government. Whether they admit it or not may not be relevant but I don't know that they would admit that they are brokers.
If you look at the Integrity Act, there's specific provisions about the sweeping extent of the extra-territorial application of the Act for purposes of all Federal securities laws, including, by definition or at least by inclusion, the ‘34 Act (Securities Exchange Act of 1934).
I don't know that being off-shore and being a migration agent associated with raising money for what is clearly a U.S. transaction makes you exempt, but certainly being in China makes you very far away.
I think everyone knows that the SEC and FINRA have looked at this market long enough that if they wanted to call migration agents brokers, they could have done so a long time ago. I think there's some confusion on that.
I'm not saying that Michael’s view, that these off-shore agents may not be subject to regulation, is wrong. What I'm saying is I'm not clear that they're exempt. It would be nice if the SEC or our group of securities lawyers could achieve clarity on that because if they were deemed to be non-exempt, then the payments they're receiving could only be received by them if they were deemed finders.
And we all know that their involvement in the negotiation would not allow that particular characterization or they would have to be deemed foreign associates to broker dealers, which would bring broker dealers squarely into this market and would then eliminate the need for regional centers to have to play this role.
Ronnie: I have a little different philosophy on some of these points. I think we've got to distinguish between the ‘33 and ‘34 Acts. I don't think we're intending to impose the ‘33 Act obligations on foreign brokers who are marketing. Are we making them responsible for the offering materials if they're not principals?
Let's understand. When the Chicago Convention Case came down, that was a ‘33 Act case. I talked to the chief SEC litigator, Steve Cohen, about that case after it was filed. He was very clear to point out that the whole jurisdictional issue included the ‘33 Act and not the ‘34 Act. This was a fraudulent securities offering.
Jurisdiction, even though allegations in the complaint, that could have scared somebody that the Reg S exemption was going away since money was wired to the U.S. and the subscription documents were accepted in the U.S.
I think when we get to all these compliance and integrity issues, we really need to distinguish who are the ones that are promoting the project, not selling it or issuing the project, let's say, because the promoter is a very loose term.
Greg: Ronnie, what I'm saying is that if you're talking about the promoters which is what I was talking about, nobody's claiming that the migration agents are issuers and should have liability under the ‘33 Act, unless they were also control persons.
I think we were talking about them in the context of being finders, locators of money, brokers or whatever you want. That's the ‘34 Act.
Ronnie: Yeah, but here's where we get into a slippery slope, which I'm having the problem with. I agree that there's got to be a standard for issuers. Whether we want to impose that and make a regional center a guarantor of that is a different animal.
Somebody is an issuer. It could be a regional center. It could be a developer. It could even be a marketing agent that sets it up. Somebody is promoting the project and generating the package that's going to be used to sell the security. I think we all agree there needs to be standards.
I agree that there are EB5 broker dealers like Kurt’s firm Primary Capital that provide a lot of value. He said they don't market or sell. They just provide guidance and due diligence. That's a good function; when broker dealers do that function, I applaud them.
Now some regional centers, developers or even marketing agents do their own diligence. That doesn't mean they're right or wrong. It just means they have their own ability to comply. That's generally the norm in the industry today.
I'm surely not suggesting, especially in the mega-projects, that there's a lack of diligence because generally there's a lot of diligence with multiple professionals, multiple law firms, feasibility studies, loan documents that are prepared by major law firms and are highly negotiated, title reports and the like. That's the norm in the industry today. But at the end of the day the buck's got to stop with somebody. When it comes to issuing a security, somebody needs to be responsible. The Integrity Bill seems to make the regional centers responsible.