Regional Centers[1]
lawfully raise capital within the EB-5 Program[2] 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[3]
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.[4]
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.
As to the nature of the purchaser, the relevant "accredited investor" category
for EB-5 offerings is "natural person" since only individuals can secure green
cards under the EB-5 Program. A person is an accredited investor if they have
annual income greater than $200,000 (or $300,000 joint annual income with his
or her spouse) or a net worth over $1 million, not including his or her primary
residence or debt secured by the primary residence.[5] The SEC recognizes that imposing specific
reasonable steps when the potential investor is a natural person poses great
difficulties in practice because the requirement would inevitably require
potential investors to disclose their personal financial information, thus
raising privacy concerns. However, the
amount and type of information that the issuer possesses about a purchaser
could be a significant factor in determining what additional steps may be
reasonable to verify the purchaser's accredited investor status. The SEC stated that the more information an
issuer has indicating accredited investor status, the fewer steps an issuer
would be required to take. Conversely,
the less information a regional center has regarding whether a purchaser is an
accredited investor, the more steps it will be required to take to show that it
has taken "reasonable steps" to verify the investor's accredited investor
status.
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[6].
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.[7]
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[8]
and requiring the Form D to be filed in advance of any general solicitation,[9]
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.
Conclusion:
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.
Also
contributing to this article:
Jennifer
Moseley 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 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.
[1] This 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."
[2] See 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).
[4] SEC ELIMINATING THE PROHIBITION AGAINST GENERAL
SOLICITATION AND GENERAL ADVERTISING IN RULE 506 AND RULE 144A OFFERINGS
Release No. 33-9354 dated August 29, 2012, page 19.
[5] Definition of accredited investor: http://www.sec.gov/info/smallbus/secg/accredited-investor-net-worth-standard-secg.htm (Last retrieved on July 14, 2012)
[6] Id. P. 19
[7] Although 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.
[8] Letters 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).
[9] Letters from Fund Democracy, NASAA (July 3, 2012) Public Citizen.