EB-5 Practice under SEC Proposed Rules to Implement the JOBS Act
Regional Centers lawfully raise capital within the EB-5 Program  pursuant to one or more exemptions from registration set forth in the United States securities laws. The most commonly utilized exemptions in EB-5 offerings are Regulation D (the Private Placement exemption) and Regulation S (the Offshore Offering exemption) each promulgated under the Securities Act of 1933, as amended. Without a valid exemption, companies raising money under the U.S. securities laws must register with the Securities and Exchange Commission ("SEC") and disclose substantially similar information as a company "going public." Failure to comply with Regulation D, Regulation S or the onerous disclosures required by registration will subject an issuer to penalties and fines by the SEC which can be equal to or greater than the amount raised by the regional center in its non-compliant offering. Furthermore, the regional center's own investors can sue to recover the full amount of their investment.
On August 29, 2012 the SEC proposed rules (referred to in this article as "proposed rules") to the most relevant section of the JOBS Act to Regulation D: to repeal the prohibition on general solicitation and general advertising rules for private placement offerings conducted pursuant to Rule 506 of Regulation D, provided that all purchasers are accredited investors. The criteria for being an accredited investor are discussed later in this article. In addition, the proposed rules would require that issuers who use general solicitation or general advertising take reasonable steps to verify that the purchasers are accredited investors. Finally, the proposed rules would amend the SEC's notice requirement for issuers utilizing Regulation D (filed on Form D) to add a check box to indicate whether an offering is being conducted using general solicitation or general advertising. This article focuses on the impact the proposed rules, if adopted by the SEC, could have on the use of Regulation D and Regulation S within the EB-5 practice.
Will a Regional Center Be Able to Conduct General Solicitation and General Advertisement Under Regulation D if the Proposed Rules are Adopted?
Yes, if (1) all purchasers of the securities are accredited investors, as defined in Rule 501 and (2) the regional centers take reasonable steps to verify that the purchasers are accredited investors. Once the new rules are adopted by the SEC, regional centers will be able to reach out to potential investors through general solicitation and general advertisement such as through website advertisements, newspapers, magazines, radio, television and internet broadcasts and e-mail. However, the proposed rules do not give a regional center carte blanche to solicit investors for a private placement offering. The proposed rules would require regional centers to take more thorough measures than are commonly used today to determine the accredited investor status of the purchasers of their securities.
Most issuers of securities, both in and out of the EB-5 context, have typically relied on a "suitability questionnaire" to determine whether a potential purchaser qualifies as an accredited investor. While a few issuers will ask for specific bank account information and tax returns, many simply rely on the potential purchaser to check a box indicating how he or she satisfies the accredited investor thresholds. The SEC has traditionally allowed an issuer to rely on the representations made by its investors, so long as the issuer has no reasonable belief that the representation is incorrect. This simple "check the box" practice, however, probably could not be relied upon by a regional center that wants to conduct general solicitation and general advertising under the proposed rules. Instead, the regional center would be required to take "reasonable steps" to verify that the purchasers are accredited investors. In other words, it is not good enough under the proposed rules that all purchasers declare themselves to be accredited investors. The regional center must take reasonable steps to verify its investors' accredited investor status.
What "Reasonable Steps" Should the Regional Center Take?
The SEC did not specifically define "reasonable steps," and made it clear that it intends to provide sufficient flexibility to issuers since what is reasonable depends on the circumstances of a specific transaction. However, the SEC, in its proposed rules, strongly indicated that the current "questionnaire" practice to verify the accredited investor status of the potential purchaser would no longer be sufficient.
The SEC stated that whether the steps taken are "reasonable" would be an objective determination, based on the particular facts and circumstances of each transaction. In the proposed rules, the SEC provided examples of factors it would consider in order to determine whether the steps to verify accredited investor status were reasonable:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the issuer has about the purchaser; and
- the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
Finally, as to the nature of the offering, an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer .
EB-5 offerings by regional centers will always be to natural persons and would most likely be done through a website or other widely disseminated method (such as email) as a result of the practical challenges of soliciting purchasers who reside outside of the U.S. Thus, it appears that, based on the proposed rules, regional centers would have to take more steps to verify accredited investor status, such as obtaining more reliable information from the potential purchasers. Regional centers may want to consider obtaining source of funds documents at the onset, as a condition to providing a potential purchaser with a Private Placement Memorandum or other offering materials, or at the very least, prior to accepting any subscriptions. Regional centers would still have to consider whether the source of funds documentation is sufficient to show accredited investor status such that the regional center would meet the proposed "reasonable steps" requirement. For example, if an investor's source of funds is a gift by a relative, this investor's source of funds documentation will be less useful in verifying accredited investor status. In its proposed rules, the SEC specifically stated that in determining reasonableness, it would take into account whether the investment was made with cash that is (or is not) financed by any third party. Conversely, the SEC stated that if there is a high minimum amount of investment, it may be reasonable for an issuer to take few steps (or even none) to verify accredited investor status other than to confirm that the purchaser's cash investment is not being financed by a third party (absent any other facts that indicate the purchaser may not be accredited).
It is important to note that the SEC, in its proposed rules, continues to recognize that the requirement that the purchasers are accredited investors is met if the issuer reasonably believes that the purchasers qualify as accredited investors at the time of the sale of the securities. This means that if a purchaser provided false or fraudulent information or documentation, a regional center would not face liability for failing the condition that all purchasers are accredited investors, provided the regional center did not reasonably know that the information was false or fraudulent.
Is the Regional Center Required to File a Form D?
Under the current rules, any regional center that relies on an exemption from registration pursuant to Regulation D is required to file a Form D - Notice of Exempt Offering of Securities with the SEC within 15 days after the first sale of securities in the offering. The Form D discloses information regarding the issuer of the securities; information about related persons (executive officers, directors, and promoters); identification of the exemption or exemptions being claimed for the offering; and factual information about the offering, such as the duration of the offering, the type of securities offered, and any commissions or other payments to third parties in connection with the offering on behalf of the issuer. The SEC has proposed amending the Form D to add a new check box for an issuer to indicate that it is relying on the new "Rule 506(c)" exemption allowing general solicitation. The SEC's view is that this disclosure would allow it to better monitor private offerings conducted using general solicitation and that purchasers in those transactions need more oversight and protection against fraudulent activities by issuers. While some commentators suggested conditioning the availability of the proposed Rule 506(c) exemption on the filing of Form D and requiring the Form D to be filed in advance of any general solicitation, the SEC declined to include those changes.
Will a Regional Center's General Solicitation and General Advertisement Have Any Ramifications on the Regulation S Exemption?
Many regional centers rely on the dual protections afforded by the Regulation D and Regulation S exemptions. If the criteria for one of the two exemptions are inadvertently unsatisfied, the other exemption, if valid, will maintain the regional center's protection from this type of securities law liability. Dual exemptions are an effective way to reduce securities law risk, especially since the SEC has not given much guidance with respect to certain EB-5 practices.
The Regulation S "offshore exemption" has several requirements, one of which is that there should be no "directed selling efforts" within the United States. Many methods of general solicitation or general advertisement, such as online advertisement (which can include posting descriptions of an offering on a regional center's website) may be deemed to be directed sales efforts. Since these selling efforts are accessible to individuals in the United States, a regional center utilizing these advertisements would not be in compliance with all requirements of Regulation S. Therefore, taking advantage of the freedom to conduct a general solicitation or general advertisement under the proposed rules relating to Regulation D may eliminate a regional center's ability to rely on Regulation S. Therefore, if a regional center conducts a general solicitation or general advertisement under the proposed rules relating to Regulation D, but does not take reasonable steps to verify accredited investor status of its investors, this regional center is in danger of having no valid exemption to the registration requirement.
The SEC's proposed rules resulting from the JOBS Act could significantly change the landscape of EB-5 subscriptions and offerings. Though the regional center may have more leeway in general solicitation and general advertisement to reach out to potential investors, the burden and costs to comply with securities law may increase significantly due to the requirement that issuers take reasonable steps to verify the accredited investor status of its purchasers.
Since the "reasonable steps" requirement would be a condition to the availability of the exemption under the new proposed Rule 506(c), the proposed rules create a need for legal practitioners with expertise in both securities law and EB-5 law. This dual expertise will be necessary in order to better advise the EB-5 community with respect to the nuances of the changing legal environment and gray areas regarding the interpretation of "reasonable steps" if the proposed rules are adopted by the SEC.
Though the proposed rules may still leave regional centers unclear as to how they can conduct general solicitations and general advertisements while maintaining an exemption from registration, it is very clear from the proposed rules, that regional centers must take significant measures to adopt policies and procedures governing how they obtain and maintain documentation regarding potential purchasers' financial information and accredited investor status. Everyone taking advantage of the new general solicitation and general advertisement rule will be required to alert the SEC of that fact on a Form D, filed shortly after the offering commences.
Finally, an analysis of the business and marketing advantages to be gained from general solicitation and general advertisement should be weighed against the potential pitfalls of losing one or more securities law exemptions. Not all regional centers will be best served by taking advantage of the greater marketing opportunities allowed by the proposed rules.
This article is a general summary of complex securities law issues. No legal advice is provided in this article. Please consult a securities attorney for advice applicable to your particular circumstances.
1This article refers to the regional center and the issuer of the securities (such as a limited partnership formed by the regional center) generally as the "regional center."
2See Generally, Section 203(b)(5) of the Immigration and Nationality Act, as amended, the Departments of Commerce, Justice and State, the Judiciary, and Related Agencies Appropriations Act of 1993, Pub. L. No. 102-395, section 610, as amended, and all applicable regulations promulgated thereunder.
3 Rule 502(c) of Regulation D, also at 17 CFR 230.502(c).
4SEC ELIMINATING THE PROHIBITION AGAINST GENERAL SOLICITATIONAND GENERAL ADVERTISING IN RULE 506 AND RULE 144A OFFERINGS Release No. 33-9354 dated August 29, 2012, page 19.
6Id. P. 19
7Although Regulation D preempts state registration requirements, each state also requires a notice filing, which is typically a copy of the Form D filed with the SEC, along with a filing fee. Regional centers should determine which states' securities laws are applicable to it in order to determine the applicable filing requirements.
8Letters from Massachusetts Securities Division ("The filing of a Form D should be a condition of the availability of the new Rule 506 exemption."); North American Securities Administrators Association, Inc. ("NASAA") (July 3, 2012).
9Letters from Fund Democracy, NASAA (July 3, 2012) Public Citizen.
Yi Song, Esq is an associate attorney at Mona Shah & Associates in New York City. She is also licensed to practice law in People's Republic of China. She has practiced tax law in Beijing, China with a leading tax firm. She clerked at China's high court - the Supreme Court of People's Republic of China. At Mona Shah & Associates, Yi practices EB-5 law and securities law and works on many successful EB-5 capital raising projects. She obtained her LL.B. degree from Beijing Foreign Studies University and she is a graduate from Georgetown University Law Center in Washington, DC. Yi is a native speaker of mandarin Chinese. She speaks fluent English and basic French.
Jennifer Moseley, Esq is a partner at Burr & Forman, LLP Birmingham Office in Alabama. She also represents public companies in connection with their Exchange Act reporting requirements and stock exchange matters. Jennifer is a member of the Alabama State Bar, the New York State Bar, the Birmingham Bar Association and the American Bar Association. She is admitted to practice before the United States District Court for the Southern and Eastern Districts of New York. She serves as a member of the firm's Recruiting Committee. In 2012, Jennifer was named an Alabama Super Lawyers "Rising Star" in the Business/Corporate practice area. Jennifer received her B.A., cum laude, from New York University, and her J.D. from Cornell Law School. Jennifer speaks Korean.
Clem Turner, Esq is a shareholder and the Managing Attorney of the New York Office of Homeier & Law, PC. Clem practices in the area of general corporate, corporate finance and business transactional law. With over15 years experience in the corporate and business transactional fields, Clem brings a deep level of legal knowledge and expertise to the EB-5 industry. Clem has counseled numerous corporations and Regional Centers raising capital through the EB-5 Program on matters of structuring, strategy, securities law and corporate law, with a collective aggregate deal value of over $500 million. Clem received his B.A. from Princeton University and his J.D. from Georgetown University Law Center. He is a member of the New York State Bar and California State Bar.