Kurt: Let’s start with a very simple question. Who is advising the investment vehicle entity? Lori, when we say entity, what do we mean?
Lori: It's typically an entity or a person, but generally the entity is acting as a general partner or the managing member of a limited partnership or a limited liability company which is investing in something that could be considered an underlying security.
That general partner or managing member might be considered to be an investment advisor by the SEC or certain states, if that person is providing investment advice, picking the security or supervisory services of the security with regard to the funds, (the limited partnership or the limited liability company).
Kurt: Cathy, could you talk a little bit about ‘regular and continuous supervisory or management services’ as stipulated in the regulations?
Cathy: Believe it or not, this is a key issue because it impacts whether or not a general partner or managing member are going to be subject to SEC registration rules or, alternatively, be subject to their state's investment advisor registration rules.
Pursuant to the recent changes in the Investment Advisor's Act that were required by the Dodd-Frank Law that came into effect in 2011, the SEC's rules have changed so that as it stands today, if you are an advisor with regulatory assets under management of $100 million or more, which is the general standard, you are subject to SEC jurisdiction. If you have less than $100 million of regulatory assets under management, you're subject to your state's investment advisory laws. You would have to look at the laws of your state.
Now, the SEC defines the term "regulatory assets under management" in the instructions to the Form ADV. It states as follows: "In determining the amount of your regulatory assets under management, include the securities portfolios for which you provide continuous and regular supervisory or management activities as of the date of filing Form ADV."
The SEC instructions further define what they mean by "regular and continuous supervisory or management services." They say you are providing those types of services if you have discretionary authority to allocate clients' assets among various mutual funds or if you allocate assets among other managers or you do not have discretionary authority but you provide the same allocation services.
But, they also say you do not provide continuous and regular supervisory or management services if you make an initial asset allocation without continuous and regular monitoring and reallocation or provide advice on an intermittent or periodic basis, such as upon client request in response to a market event or on a specific date.
I think that regional centers and other EB5 general partners and managers of funds could take the position that they are not providing continuous and regular supervisory or management services because all they do is make one single investment.
The only time that would change is if there was an early repayment that required a reinvestment. But other than in that instance, it appears to me to mean they're not providing continuous and regular supervisory services.
Therefore, it will never hit $100 million in regulatory assets under management. Therefore, they have to the look to the laws of the state to determine whether or not they're required to register.
Kurt: How much of a concern is it to you, considering the USCIS requirement of keeping an investment at risk and perhaps needing to reinvest the entity's funds, if your investment entity is not registered as an investment advisor?
Cathy: I think that’s covered by the language that I read. You are not providing continuous and regular supervisory or management services if you provide those services on an intermittent or periodic basis, such as at the client’s request, or in response to a market event or on a specific date. If all you do is reallocate the assets of a fund when there is an early repayment and all you do is one single reinvestment, that would not be construed as regular and continuous supervision, according to the SEC's own instructions.
Kurt: Chris, what's your philosophy on this point?
Chris: I don't necessarily disagree, although I don't think it's that clear. In March of 2013, the staff of Investment Advisors Regulation Office for the SEC published a memo regarding the rule changes from 2013. One of their points was that you can be considered to be providing securities advice if you are providing a selective list of securities, which many of these regional centers may be doing. Although they are not advising as to the benefit of one security or another, they are telling investors, "These are the securities or the EB5 projects which we currently have available." This may be deemed advice.
Cathy: I think that's a different question. What you're saying is that these regional centers may be acting as investment advisors to individual investors by making a selective list available. That's not going to the question of “is the general partner or managing member acting as an investment advisor to the fund?” It's a very different question.
Chris: Understood. I think that's exactly the point; that I don't think it's as cut and dried as those instructions may make it seem.
Kurt: I think this is really interesting and what I want to stress to the audience is that every decision you make along the way has an implication on your next decision. The decision Cathy is referring to is who is the client of the managing member? The first thing we need to determine is whether the managing member is acting as an investment advisor to the fund. Isn’t that right, Cathy?
Kurt: Then once you decide that question, it begs the question, “given that investors are investing in the NCE’s fund and the various decisions the makes along the way, are you advising them? Bob, do you have any thoughts as to the investors’ role in all this? Because if the managing member is really the advisor to the fund, where does that place the investors?
Bob: It places them in a regulatory limbo, as far as I'm concerned. One of the issues we have to be concerned with is the decision you make as to how you're structuring your fund is going to govern what your registration dynamics are.
For example, in the EB5 context we generally know that there is a loan-to-equity model that is frequently used in EB5 transactions as mezzanine financing. That is, you have a fund which is loaning money to an entity which is ultimately providing that money to another entity for deployment in a project.
The question becomes in the midst of all that, is someone advising the fund as to the disposition of the assets or the money that is being loaned?
My view is that there is some disposition that involves some investment advisory activity given the context that the advisor, managing member or whatever entity you're talking about, has already been granted a great deal of discretion through the fund documents. They have the discretion as to how they deploy those funds, even though there is a general description as to what it's going to do.
Is the question of that fund's discretion going to drive the analysis of whether there's investment advisor registration involved?
Then as Chris had intimated, you get into the question of whether those entities are actually advising the investors themselves, the limited partners.
We've talked about the fund as a client and the reason we've emphasized that is because that client is one client. That’s an issue for everybody considering registration because you certainly don't want to go over a threshold which would trigger registration. There are certain things that you do or don't do that can trigger that.
Kurt: Lori, what's your feeling on this dynamic?
Lori: I think it's hard to know exactly how the SEC or the state regulator will view the regular and continuous supervision language in light of the specific facts of the funds you're dealing with. If you take the position that you are practicing regular and continuous supervision, you take a risk. I think all of our clients take risks every day in interpreting the securities regulations.
It would be safer to register if you think you might be deemed to be doing that or if you think that the chance of a reinvestment decision might put you in that category. Of course, it could be interpreted either way, which is a matter of risk.
Then the second question would be what is the aggregation point? Say you, as a general partner, are advising what would be deemed multiple funds or multiple limited partnerships. Although you may only make one decision with regard to each one, under Cathy's argument you would not be deemed an investment advisor.
On the other hand, I could see where the SEC or the state regulatory agency could argue, "Yes, but for each fund you're making a different recommendation or providing different advice.”
All of that together could be deemed regular and continuous supervision. I understand that doesn't fall directly under those definitions but I think it would be a consideration that the SEC or state regulators might consider.
Cathy: I recognize that the ‘regular and continuous supervision provision’ is a slim thread to hang on to, but here's the problem. We don't have any other exemptions available. If you don't choose to go with this exemption, then you're going to have to choose to register as an investment advisor, once you go over $100 million in investments under management in your total funds.
I have to tell you that that in itself is going to create additional risks for you because, at that point in time, you're going to subject yourself as a regional center to not just the exam requirements but also all of the compliance requirements that apply.
Not to mention being subject to examination on a periodic basis by the SEC, which means that you could be doing other things wrong that are going to get you in trouble with the SEC, if that's not your business and you don't understand how to run that business.
I think you have to weigh the different risks that would apply. You can accept that you want to take the exemption and understand that there's a risk to that decision. Or, if you prefer, you can decide to take the risk and become a registered investment advisor. That, in turn, could potentially open you up to other things that you might be doing wrong as a registered investment advisor.
Kurt: Chris, any thoughts on Cathy’s point, which is that ‘regular and continuous supervision’ may be a thin thread but that it is a situation that at least it gives you an argument?
Chris: If it's your last resort, that argument is better than no argument. But in my opinion, the SEC has made the EB5 program a point of supervision this year. I think it would be painful for your client to be the first one that they cracked down on because you decided to hang your hat on an argument which, admittedly, has not been fully vetted.
I would hope to see a little bit more guidance or at least a no-action letter from the SEC before I took that stand.
Although it could end up being the argument that wins the battle down the road, I just think that, this early in the game, it might be in some regional centers' best interest to just register, given the amount of projects they have done in the past, etc.
For other regional centers, however, I may give different advice. Essentially, the decision depends on the regional center.
*NOTE: Consider getting a written registration opinion from a law firm. And as you do more funds your requirements may change.