If the Suit Fits - FINRA Rule 2111 and EB-5 Offerings
In what may be FINRA's first interpretative letter involving the EB-5 program, on August 26th, 2013, FINRA replied to a member firm's (broker-dealer) request for guidance on Rule 2111 - Suitability Standards. The full letter can be found at the following link: http://discuss.ilw.com/content.php?2405-News-FINRA-Rule-2111-Suitability
According to Rule 2111, broker-dealers and their representatives must abide by specific obligations prior to recommending a security:
A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
The full rule is available on FINRA's website at:
The FINRA staff author makes several affirmative pronouncements that should be of interest to those in the EB-5 community. Firstly, that EB-5 offerings are securities, as defined by the Securities Act of 1933, as amended. The letter specifically cites the SEC's recent prosecution of a regional center developer in Chicago in support of their position. While the arguments to the contrary are creative, it would be highly inadvisable for anyone involved with EB-5 offerings to rely on the position that their actions are not subject to SEC jurisdiction on the basis that the offerings do not involve securities.
The letter then addresses the applicability of the suitability rules in the EB-5 context. Here FINRA makes it very clear that for EB-5 offerings, including those that rely on the private placement exemption (Regulation D), the broker-dealer "should, at a minimum, conduct a reasonable investigation concerning the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering." [Quoted from FINRA's guidance on Reg. D offerings, Regulatory Notice 10-22 (Apr. 2010, cited in the letter.]. The letter specifically notes that, with respect to EB-5 offerings, the broker-dealer must also "analyze whether the private placement is consistent with the requirements of the EB-5 Program, such as whether it constitutes an investment in a domestic project that will create or preserve at least 10 jobs for U.S. workers." Ironically, the initial request sought to have a lower level of obligation for broker-dealers in the context of EB-5 offerings and with this, FINRA has made it clear that there is actually an additional level of obligation.
The additional obligation is simply recognizing that the relevant investment considerations for EB-5 investors include non-financial risks, namely, immigration status risk. FINRA should be applauded for making the leap. An EB-5 investment, while a security, is a different kind of investment compared to anything else in the market because of its nexus with the investor's immigration goals and status (not to mention the Immigration Nationality Act).
Broker-Dealers who are increasingly participating in EB-5 offerings should evaluate their activities in this context. Due diligence procedures for EB-5 issuers and offerings need to specifically include labor creation of the issuer. An added nuance is for the broker-dealer to understand an issuer's direct labor creation profile in the context of non-regional center offerings, and then in the context of regional center offerings, how the econometric model works in relation to the indirect and induced labor creation. With regional center offerings, some attention should be paid to how likely it may be that the business may require a material departure from the assumptions stated in the business plan and econometric model that will be filed as with USCIS. Some businesses, both themselves, and the sectors in which they operate, are more variable/riskier. This creates added relative risk that the business would need to undertake a material change during its operations and therefore would create the risk of a rejection by USCIS of the investor's request to remove the conditional status of his/her permanent residency via his/her I-829 petition.
Following the due diligence informational gathering and analysis, the core of the suitability analysis is then to help ensure that the investment profile of the given opportunity is well suited for the given investor. This recognizes that not all investors are the same. Typical 'know your client' protocols need to be supplemented with questions that will help the broker-dealer understand the EB-5 investor's risk tolerance with respect to his/her immigration goals, in addition to the typical understanding of risk tolerance with respect to the common issues of loss of investment capital and profits. Investors who are primarily concerned with the financial outcome of the investment may be better suited for projects with a greater degree of immigration status risk compared to those who are primarily concerned with their immigration goals being met.
This is an exciting time for the EB-5 program. It is growing and getting more popular with both investors and other market participants such as broker-dealers. In concert, those who regulate the markets and its participants are paying greater attention. There will be growing pains, without a doubt, but the result will be a better, stronger, more securities-compliant EB-5 community, which, in turn, will engender greater investor confidence and participation.
Matt Gordon is a the Managing Director of E3 Investment Group. He is a finance professional whose vision and passion is to help realize extraordinary value through the flawless planning and execution of strategy, financings and transactions that foster aggressive sustainable growth. Mr. Gordon is a licensed attorney, having practiced law with some of the most prestigious Wall Street firms, including Fried Frank and Sullivan & Cromwell. He is a member of the New York State Bar and holds SEC securities licenses.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.