Kurt: Lori, Could you give us your thoughts about the need for a broker-dealer in EB-5 transactions?
Lori: Since I'm the only person on the panel who doesn't work for a broker-dealer, hopefully I'm objective. Let me begin by saying that every deal is different and thus all the facts are different. Obviously, we take that into account when we advise participants in an EB5 offering what they need to do. Generally, however, we believe that participants, whether issuers or regional centers, could have a better outcome if they associate with a broker-dealer, especially in regard to the following topics:
- Reg D private placement exemptions;
- Whether a general solicitation is possible (meaning you can advertise your private placement under 506(c));
- Whether you've met the requirements which prove you've verified that all of your purchasers are accredited investors; and
- Ensuring compliance with Reg S and that you’ve appropriately filed with the SEC.
Now, all of these topics tend to involve actions that a broker-dealer is very qualified to undertake. A broker-dealer will perform the due diligence necessary to ensure that you are meeting the requirements of these particular regulations and that the offering is properly marketed and sold. Beyond that, a broker-dealer might also recognize or advise on other topics, such as whether you are taking some action that lead you to be “deemed” an registered investment advisor.
I can't stress enough that these type activities are what a broker-dealer who is involved in private placements does every day in the US securities market. The only difference is that these securities are being marketed overseas. In that respect, a broker-dealer is uniquely qualified to assist EB5 participants. I can't necessarily assert that with every single EB5 offering, you need to associate a broker-dealer, but we generally think it's a best practice.
Kurt: John, would you mind walking us through how Reg D and Reg S offerings should be handled in EB5 transactions?
John: Well, a Reg D offering would be specific to US investors as opposed to a Reg S with foreign investors. In our opinion, and I would say most attorneys would agree, the regulations are very clear on the Reg D marketing. If you're marketing a transaction to investors in the US, there are very specific procedures that you need to follow. In terms of paying compensation, there are specific requirements and procedures that need to be followed. Those are easily tracked by the SEC as well as FINRA. Historically, most transactions that we've been involved with were Reg D.
The 506(c) offerings, which are the general solicitations, are typically run through general solicitation websites. For a lot of those, the back end is a broker-dealer that provides basic services. Those sites are designed to be fully automated and typically, an investor is simply going to log in. I would say that most 506(c) general solicitation websites are specifically designed only for US investors. Thus, these fully automated sites might not be well suited for a foreigner as, beyond the login, the procedures may be difficult. Moreover, I haven’t seen any sites where the language has been translated into Mandarin or Cantonese.
Kurt: John, how difficult would it be to do a general solicitation based on the accreditation rules for investors? Would that be difficult in EB5?
John: Well, I think the trend is to split the marketing more between the US and China. China's becoming an expensive place to do business. A lot of issuers are looking for more economical means of raising capital, and a 506(c) offering is more economical than paying agents large fees, spending time in China, and traveling back and forth.
And more and more we're seeing a larger number of Reg D investors that are coming from agents in China. In large offerings that are, say, north of $50 or $100 million in EB5 money, and even though the agents are based in China, it’s been my personal experience that about 20% of the investors are really Reg D investors and not Reg S investors. They could be solicited under or captured under 506(c).
To answer the question of verifying investor accreditation, you do have to take some extra steps. Typically, under Reg D, investors are going to check off a few boxes, and they’ll tell us they're accredited, and that will be the end of it. Under 506(c), you're required to take extra steps. That could include getting a copy of a tax return, getting a third-party advisor (accountant, banker, etc) to support the assertion that the investor is accredited. It's not just taking the investor at his word and believing that they're accredited simply because that’s what they’re telling you. On the general solicitation websites, that paperwork, as I said, is all done online. But it is specifically set up for US investors.
My expectation is that the trend is going more and more towards capturing Reg D investors directly, which would include general solicitation or crowd funding.
Kurt: What about Reg S, John? What do you think about the issuers who decide, "Hey, we want to focus exclusively on Reg S." Do they need a broker-dealer?
John: I would agree with Lori that there are exceptions. I've seen very, very few. Say you're doing one transaction annually, and all your communications are taking place outside of the US. You, as a developer, are not specifically involved in the business of raising capital; rather you have another full-time business. Under those conditions, you would qualify for the issue exemption. But that's very rare.
Most issuers have multiple transactions. They're setting up these New Commercial Enterprises one after another. My expectation is that the SEC would view that as you're trying to circumvent a regulation and likely come down on you harder than someone who was just doing a transaction where one rolls into another.
As an example, I point to Related Companies; they are one of the largest private US developers. They own a broker-dealer. They're not in the securities business. They're in the EB5 business. They have the ability to get the best legal advice available. They have seemingly unlimited resources. They raise a lot of money overseas under Reg S, and they equip themselves with a broker-dealer. Certainly, if you're communicating in the US, you're subject to the SEC regulations.
Lori: Let me just reinforce the point that Reg S doesn't provide any kind of safe harbor for Blue Sky laws (state securities laws), which is another reason why, even though you might be exclusively offering securities pursuant to Reg S, you might still need a broker-dealer’s involvement to ensure compliance with these state laws.
John: Based on my personal experience in the EB5 space most Reg S offerings are not “true” Reg S offerings. The reason being, most agents maintain an office in the US and they are essentially engaged in broker-dealer activities as an unregistered broker-dealer. Now, understand that the SEC and FINRA do attend EB5 conferences; they’ll stop by an issuer’s table and pick up marketing materials. I know some issuers that have had discussions with a person who appeared to be an interested investor. As the “interested investor” walked away they asked, "Oh, can I have your card?" It was securities enforcement agent.
When the SEC or FINRA says it's a priority, believe me, it's a priority. They are acquiring information, mostly marketing materials. At some point in the future, you'll get a letter; "I want the PPM." You want to make sure the PPM matches up with the marketing materials.
They're researching the agents to see if these agents do maintain a place of business in the US. There was a recent conference out on the West Coast where agents were located. I would guarantee you that FINRA and/or the SEC attended that conference, and they picked up cards of agents, and they'll be following up with them to see where they're actually located.
If you're engaged in a Reg S transaction, you need to make sure everybody is offshore. If you're engaging an agent to raise capital, and if they have an office in LA or in New York, you potentially have a problem with your transaction.
Kurt: I have a question that often seems to be a gray area. The issuer exemption allows for a one-time per year offering allowance. I make the argument that if you spend a year marketing an offering then you essentially have to wait another year until the offering is concluded before you're allowed to start your next offering, regardless of the entity or issuer you are raising money for. So doesn’t this mean that you are effectively looking at one offering every two years?
John: I would agree with that. It takes between 12 and 18 months to complete a decent sized EB5 offering. Upon completion, you would need to wait 12 months. Lori, do you agree or do you have another opinion?
Lori: That's certainly the safer way to count. The language of the Rule indicates that there should be a 12 month waiting period after completion of the offering, so that's probably what you would want to do.