Intersection of Securities Laws and EB-5 Transactions - Securities Laws Compliance Guidance for Immigration Attorneys
When an EB-5 transaction involves the sale of LLC or LP interests, etc. to EB-5 Investors, the transaction involves the sale of “securities” and is subject to the applicable federal securities laws (and applicable state securities laws if the offering is made to investors who are in the U.S.). The New Commercial Enterprise (“NCE”) and possibly also the Job Creating Enterprise (“JCE”) should work with a securities attorney to assure compliance with the applicable securities laws.
RELEVANT FEDERAL SECURITIES LAWS & OVERVIEW:
Securities Act of 1933,
Securities Exchange Act of 1934, and
Investment Company Act of 1940
Securities Act of 1933 (“1933 Act”)
The 1933 Act regulates the offering and the sale of securities and requires the registration of securities offered to investors in the U.S. or offered by U.S. Issuers, unless the transaction is made pursuant to an exemption from the securities registration requirements.
There are 2 principal securities registration exemptions that are generally used in EB-5 Offerings are:
(i) Reg D/Rule 506 (private placement); and
(ii) Reg S (offshore offering exemption)
Each of these exemptions are self-executing and accordingly the burden of proof is on the Issuer (NCE) to establish that it has satisfied the requirements of the particular exemption;
These are exemptions only from the securities registration requirements under the 1933 Act;
These are not exemptions from the SEC’s anti-fraud provisions.
The Issuer (NCE) will need to comply with the SEC’s anti-fraud provisions which require disclosure of material information to prospective investors;
The disclosures made to prospective investors are typically provided in a confidential Offering Memorandum and related documents given to prospective investors.
Reg D /Rule 506 Exemption - Overview
Reg D includes several exemptions, including Rule 506.
Reg D imposes conditions that must be satisfied for the Issuer (NCE) to qualify for the particular Reg D exemption, including (but not limited to):
the manner of the offering and
affording prospective investors an opportunity to meet with and ask questions and get answers from the Issuer and its management regarding the investment.
Rule 506: In connection with EB-5 transactions, the most commonly used Reg D exemption is the Rule 506 exemption. Rule 506 exempts the sale of unregistered securities to:
(i) up to 35 non-accredited investors who alone (or with a purchaser representative) have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment; and
(ii) to an unlimited number of “Accredited Investors”.
An “Accredited Investor” is a natural person who has either:
(a) a minimum net worth (excluding primary residence) of $1,000,000; or
(b) annual income of $200,000 for each of the last 2 years and reasonably expects the same income for the current year.
If the offering in the U.S. will include non-accredited investors, the Issuer will need to comply with the Reg D disclosure requirements.
However, if the offering is made only to Accredited Investors, the Issuer has the discretion to determine the information to be disclosed to such Accredited Investors.
There is no limit on the dollar amount of securities that can be sold in a Rule 506 offering.
Reg D is available only to the Issuer, not for resales by investors.
Reg D is not limited only to “off-shore” investors.
The Investors will receive “restricted securities”.
No general solicitation or advertising can be used unless the offering satisfies Rule 506(c) as follows:
(i) All investors are accredited; and
(ii) The Issuer has taken reasonable steps to verify that all investors are accredited.
Reg S Exemption
The Reg S exemption is available only for offers and sales of securities in an offshore transaction outside of the U.S.
An “Offshore transaction” takes place when the offer is not made to a person in the U.S. and either the buyer is outside of the U.S. (or the Issuer reasonably believes that the buyer is outside of the U.S.) or the transaction is executed on an established foreign securities exchange.
The Investors will receive “restricted securities”.
Reg S imposes resale restrictions to safeguard against the flow-back of unregistered securities into the U.S.
There is no minimum net worth requirement for Reg S investors;
There is no limit on the number of Reg S investors;
There is no limit on the dollar amount of the securities that can be sole in a Reg S offering;
The Issuer must comply with the securities laws of the foreign jurisdiction where the particular Reg S investor resides.
Simultaneous Rule 506 and Reg S Offerings
The Issuer (NCE) can conduct Rule 506 and Reg S offerings simultaneously so the Issuer can sell to:
(i) an unlimited number of Reg S investors “offshore” investors; plus
(ii) an unlimited number of Rule 506 accredited investors; plus
(iii) 35 Rule 506 non accredited, sophisticated investors.
The simultaneous offering can be made in a single Offering Memorandum that contains provisions to comply with both Rule 506 and Reg S.
The Subscription Agreement should contain representations to satisfy the requirements of each of Rule 506 and the Reg S.
The Issuer should determine which exemption is being relied upon for the particular investor and advise said investor which exemption is being relied upon for him/her.
Each investor should execute (as applicable) either an Accredited Investor Certification or a Reg S Certification.
Consequences of a Non-exempt Offering of Unregistered Securities
If the Issuer (NCE) does not satisfy one of the above securities registration exemptions, it will have sold unregistered securities in violation of the 1933 Act.
The non-exempt sale to just 1 investor may taint the entire offering;
The non-exempt sale may result in right of rescission to investors.
The Issuer’s principals (directors, officers, manager, general partner, etc.) may be personally liable to the investors for rescission (and in effect become insurers of the transaction).
The illegal sale may result in SEC investigation.
Securities Exchange Act of 1934 (1934 Act)
In the context of an EB-5 offering transaction, the 1934 Act becomes important if the Issuer (NCE) will be selling the securities to persons in the U.S. or engage in the securities offering from within the U.S.
The 1934 Act regulates securities and requires the registration of securities broker-dealer firms.
Often in EB-5 transactions, the Issuer (NCE) may consider using the services of a “finder”.
A “finder” is a person who is engaged in the business of offering and selling securities but is not registered as a securities broker-dealer with the SEC.
The SEC discourages the use of “finders”.
The use of a “finder” could taint the entire offering and give rise to rescission rights to the investors and result in an SEC investigation and enforcement proceeding.
Accordingly, Issuers (NCEs) are cautioned to seek advice of a securities attorney when working with a “finder”.
Investment Company Act of 1940 (1940 Act)
The 1940 Act regulates investment companies.
An Investment Company is defined as entities that are engaged in the business of investing, reinvesting or trading in securities.
The 1940 Act applies to Issuers (NCEs) because they will invest either in equity securities or debt securities issued by the JCE (or an affiliate of the JCE).
Compliance with the 1940 Act would be cost prohibitive and regulatory compliance would be prohibitive for a typical NCE.
There are 2 exemptions from definition of Investment Company that may be available to the Issuer (NCE) in the context of an EB-5 transaction:
(i) Sec. 3(c)(1) - exempts an Issuer that is owned by 99 or fewer investors; and
(ii) Sec. 3(c)5(C) - exempts an Issuer that is primarily engaged in in the business of “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate”.
The Sec. 3(c)5(C) exemption is used in EB-5 financed transactions where the total amount of EB-5 funds will be raised from 100 or more investors.
Larger EB-5 financed transactions (more than 100 investors) are structured as a loan from the NCE to the JCE (or an affiliate) that is secured by a mortgage or lien on real estate to qualify for the 3(c)5(C) exemption.
If the EB-5 transaction cannot be structured to satisfy the 3(c)5(C) exemption, the capital stack will need to be structured so there are no more than 99 investors.
SECURITIES COMPLIANCE SUGGESTIONS AND RECOMMENDATIONS
· Structure the Issuer (NCE) to satisfy the requirements of the desired securities registration exemption(s).
· Structure the Issuer (NCE) and the EB-5 financing to satisfy the requirements of the desired Investment Company definition exemption.
· Structure the transaction from the NCE to the JCE to conform to the selected exemptions.
· Draft the Offering Memorandum and related documents to satisfy the requirements of the selected exemptions.
· Provide clear disclosures of material information to comply with the anti-fraud provisions.
· If the Issuer (NCE) is going to sell any securities in the U.S., use a securities broker-dealer that is registered with the SEC.
· Avoid using a “finder” unless you have fully discussed the risks with a securities attorney and you fully understand the risks and the services to be provided by the “finder” are limited.
Rule 506 Compliance
Required Rule 506 disclosures:
· That the securities have not been registered under the 1933 Act and the restrictions on resale of the securities;
· Include a Reg D restrictive legend on the securities (LP or LLC entity agreement);
· In the Offering Memorandum, include a disclosure regarding access to additional information and the opportunity to meeting with and ask questions and receive answers from management of the Issuer regarding the investment;
· In the Offering Memorandum include disclosure regarding restrictions on general solicitation and advertising (unless the offering is made pursuant to Rule 506(c);
Additional Recommended Rule 506 Compliance disclosures:
· Have each investor represent that he/she is acquiring the securities for his/her own account and not with a view to the resale of further distribution of the securities;
· Disclose whether the offering will be limited to only accredited investors – or –whether the issuer may sell the securities to up to 35 non-accredited investors;
· If the offering will include non-accredited investors, establish and disclose investor suitability standards (i.e., net worth, sophistication, etc.)
NOTE: Offering the securities to non-accredited investors imposes greater disclosure requirements on the Issuer.
· If the offering will include Accredited investors, include the Accredited Investor definitions that are applicable to natural person investors;
· Include disclosure regarding restrictions on general solicitation and advertising (unless allowable under Rule 506(c).
Reg S Compliance
Recommended Reg S Compliance:
· Disclose the limitation of sales of the securities to only investors in “offshore transactions”;
· Have the Reg S investors represent and warrant on a Reg S Certification form as well as part of the Subscription Agreement that they are not U.S. persons and that the transaction is an “offshore” transaction;
· Disclose the limitations on resales of the securities.
1940 Act Compliance
Recommended 1940 Act compliance:
· Limit the offering to 99 investors or
· If offering to more than 99 investors, structure the NCE’s investment in the JCE as a loan transaction that is secured by a mortgage or other lien on or interest in real estate.
· Confirm that the NCE LLC operating agreement (or LP agreement) conforms to the terms of the transaction with the JCE (financing structure, rate of return to the EB-5 investors, extensions of time to return capital to the EB-5 investors if needed for I-829 completion; etc.), the disclosures in the Offering Memorandum, etc.;
· Review the JCE LLC operating agreement (or LP agreement) to confirm that it is consistent with the disclosures in the Offering Memorandum and the intended investment by the NCE, etc.;
· Confirm that the offering documents are consistent with terms of the Escrow Agreement;
· Review the financing transactions and confirm that any restrictions on distributions from the JCE to the NCE are accurately disclosed to the investors;
· Use a securities offering checklist.
· Consider maintaining a control log that includes for each subscriber:
(i) the name and date of the subscriber’s subscription;
(ii) the claimed securities registration exemption for each subscriber (Reg D or Reg S);
(iii) the date of acceptance of the subscriber’s subscription;
(iv) if the subscription is rejected, the reason(s) for the rejection;
(v) any additional information required from the subscriber;
(vi) the country of residence/citizenship of the subscriber;
(vii) status of the Investor’s I-526;
(viii) status of the Investor’s I-829.
· Do not sell the securities in the U.S. without confirming with a securities attorney that the sale will not trigger the requirement to register as a securities broker-dealer or otherwise violate the broker-dealer registration requirements.
· Do not sell the securities in the U.S. through a “finder” without legal advice from a securities attorney.
· Limit and conform the manner of the offering as required by the particular securities registration exemption.
· In particular, in a multi-tier transaction, review, analyze and clearly explain the overall structure and relationships among the various entities, including any distribution limitations and preferences and other material information.
· In a multi-tier structure transaction, include a schematic drawing that shows the relationship of each party.
Additional Suggested Disclosures:
Disclose, among other material information, the following:
· In bold letters that the English version of the offering documents are the controlling documents.
· The type of the offering (all or none; any and all; or minimum/maximum) and the terms of the offering
· The termination date of the offering and any right to extend the offering term, and include a right to extend the offering (from time to time) in the sole discretion of the General Partner or LLC Manager.
· The important terms of the Escrow Agreement, including terms relating to release of funds from the escrow.
· The rights and preferences of the LP or LLC interests being offered to the EB-5 investors and also disclose the rights and preferences of the securities issued or to be issued to other tiers of investors.
· In detail the type and terms of the investment to be made from the NCE to the JCE, as follows:
(i) if the investment is to be a loan, the interest rate, term of the loan, any seniority or subordination of the loan, any collateral securing the loan, and maturity date of the loan; or
(ii) if the investment is to be equity, the rights and preferences of the equity, when distributions are intended to be made and any other material terms of the equity.
· Any restrictions on distributions and repayment of the equity or subordination and payment of interest and repayment of the loan from the JCE to the NCE.
· Any restrictions on distributions from the NCE to the EB-5 Investors.
· A detailed description of the project (location, type of project, how the project is expected to generate revenue, analysis of the market for the project, competition, any required licenses and status of such licenses).
Include a cross reference to more detailed discussion in the business plan that should be provided as an exhibit to the Offering Memorandum.
· Any fees to be paid and to whom.
· Any environmental issues and environmental guarantees.
· Any guarantees provided to the senior lender
· The number of new jobs projected to be created.
· Identification and business background of management of the NCE and the JCE and regional center, including any past successes and failures.
· Potential conflicts of interest and related party transactions.
· A detailed description of the capital stack including: EB-5 financing; bridge financing; developer financing; government subsidies and benefits, traditional financing.
· Use of proceeds but also give the GP or LLC Manager the right to use the offering proceeds in other ways based on its good faith judgment for the benefit of the investors, the project and the objectives of the LP or LLC.
· Procedures for investing by the EB-5 Investors.
· Developer guarantees, if any.
· Exit strategy for the EB-5 investors.
· Disclaimer of Forward Looking Statements.
· Any legal matters of lawsuits against the Principals of the NCE or JCE or regional center.
· Restrictions on the transferability of the securities (under the securities laws and the operating (or LP) agreement).
· Either in the body of the O/M or as exhibits to the O/M:
(i) Disclosure of the business, transaction and offering risks;
(ii) Disclosure of the relevant immigration risks;
(iii) Disclosure of any tax risks;
(iv) Discussion of important and relevant EB-5 immigration matters;
(v) Discussion of important and relevant U.S. federal income tax matters.
· Include a Schematic drawing of the structure of the project including the entities in the transaction including the JCE and its affiliates and sources of funding - including the EB-5 NCE and their respective relationships.
Suggested Offering Memorandum Exhibits
Subscription Documents (including subscription agreement, EB-5 investor questionnaire, Reg D and Reg S Investor certificate, omnibus signature page);
EB-5 Economic study;
EB-5 business plan;
TEA Designation letter (if applicable);
A copy of the NCE LLC agreement (or LP agreement);
A copy of the JCE LLC agreement (or LP agreement) if the NCE is making an equity investment in the JCE;
A copy of the loan agreement and the promissory note if the NCE’s investment will be a loan;
Copy of the escrow agreement;
Copy of a current valuation report of the Project (if obtained);
A copy of the regional center’s USCIS approval letter;
A current market analysis, if available.
Copyright 2016 Jerold N. Siegan, Esq. Reprinted with permission.
Jerold N. Siegan is the founder of the Law offices of Jerold N. Siegan, Attorney at Law, Chicago,IL. He has practiced law for more than 30 Years. His practice is concentrated in the areas of corporate, securities and business transaction law.