The SEC’s Perspective on Due Diligence in EB-5 Private Offerings and the Immigration Attorney’s Role

 How much due diligence are we Immigration lawyers expected to conduct in EB-5 cases? What are the expectations from USCIS and the SEC? On the April 3, 2013 EB-5 Engagement between the SEC and USCIS, Rob Silvers opened the call by noting that USCIS has been engaging with the SEC at the programmatic and case-specific level. Mr. Silvers declined to confirm whether  this joint review of actual cases has identified endemic or repeated practices in the EB-5 program that could not only be problematic from the SEC prospective, but could also threaten the progression of the EB-5 program.  

Clearly EB-5 is an area where the average Immigration attorney lacks the expertise to navigate the myriad of financial ambiguities and corporate nuances. The general advice is to always refer the investor client to a due diligence professional. 

False statements and schemes to defraud are obvious to all, but beyond that what should the EB-5 attorney need to know when structuring and promoting EB-5investments? Can we look to the SEC to help us identify and publicize any commonly-used practices in EB-5 deal structures and marketing that are almost certainly problematic securities-wise? Or even reassure us about what is most likely safe, for that matter?  

As EB-5 project owners continue to raise capital through conducting private placement offerings to overseas securities purchasers, how to conduct securities law due diligence becomes a pressing matter in EB-5 Practice. We want to keep our job-creating American business people safe from litigation. We also do not want EB-5 to become the new asbestos or to fade based on unfounded fears.

Investor Alert in Private Oil and Gas Offerings:

The Securities and Exchange Commission (SEC) recently warned investors about certain risks and possible fraudulent activity involving private offerings of securities for the oil and gas industry. In a recent investor alert, the SEC stated that "investing in private offerings, however, carries unique risks, and private oil and gas offerings have additional risks to consider." [1]

Although the below red flags are referring to Private Oil and Gas Offerings, the pointers can be used for any EB-5 private offering. 

Red Flags in Private Offerings

The SEC published the following common investment "red flags" for private offerings:

  • Sales pitches referring to recent news events like high oil or gas prices.
  • "Can't miss" wells and "guaranteed" returns, including claims that major oil and gas companies are drilling nearby.
  • Abnormally high rates of return.
  • Unsolicited materials.
  • Sales tactics that pressure you to decide, such as "limited" or "once-in-a-lifetime" opportunity.
  • Sales pitches touting new technology, especially if it relates to getting higher production out of low-producing wells (sometimes called "stripper" wells).
  • Salesperson claims to be an investor.
  • Being asked to sign documents acknowledging that the securities laws do not apply to the investment.

Overinflated or misrepresented prospects and claims: One common thread among all fraudulent schemes, including those related to oil and gas, are claims that they are about to strike it rich, or that it is likely or even guaranteed that the returns will be too good to pass up. The rule of thumb should be that higher returns typically mean higher risks of loss.

Investing to support drilling and completion operations: The SEC has investigated many oil and gas offerings that claimed they were about to strike oil or gas and they just needed some investment to pay for drilling and completion. The promoter often omitted to explain that he owned the drilling company or planned to hire a driller at far less than what was stated on the offering or business plan, pocketing the difference. The promoter ended up making money even if the well came up dry.

In SEC v Hartmut Theodor Rose[2], promoters told investors that oil and gas production was about to start when many of the wells were actually marginal or even dry. They misrepresented the "success" of prior wells to raise funds for new wells and touted the "low-risk" opportunity as "once-in-a-lifetime."

Undisclosed Use of Proceeds

It should be noted that a project principal may violate securities law by not disclosing the full use of proceeds. The project may not be a fraudulent scheme, however, but a principal may inflate the development costs and use part of the investment capital raised to pay for personal items or unrelated business expenses. The investors should speak with industry experts and financial advisers to obtain the industry standard for the budget.

In several cases, the SEC alleged misrepresentations about what the invested funds were going to be used for. Misrepresentations and omissions about uses of investors' monies included (i) paying big sales fees to brokers, (ii) the nature and size of compensation to the promoter and employees of the venture, (iii) operating and other expenses for unrelated businesses and (iv) using the money to pay for personal items. For example, in SEC v Wellco[3], the complaint alleges that the promoters misrepresented that investors' funds would be used for oil and gas wells when, in fact, 58% of money raised went to pay sales fees as well as the promoter's personal mortgage and child support.

The Right Questions to Ask

Use of proceeds. What is my money going to be used for? Can you estimate how much of the money you raise will be used for each of the job creating activities? If commission fees will be paid, how are those fees calculated? It is reasonable to expect the company raising the money to have plans for it, particularly if the persons involved have prior industry experience. Otherwise, why are they raising that specific offering amount?

  • Related parties. Are you hiring another company to develop/manage/operate the project? Is there any relationship between these companies and the promoters and principals in the venture? How much is the promoter going to make even if the project fails? Remember that the persons involved in the offering can do quite well for themselves when the investment funds are used, for example, to pay themselves or to hire a company they own to develop and construct. They get paid even before the project is complete. Remember too that a promoter who makes his money on the front-end of a deal-that is, from selling the investment to you and benefiting from the proceeds-rather than on the fortunes of the venture-namely the actual production from the well-does not have the same interest as investors like you whose only hope to gain is from a successful venture. You should be wary of any investment project where the promoter has not invested any equity in the project.  
  • Prior experience. What is your track record in similar industry? Have you had experience with this particular location? The investors should also request for references.

Attorneys who provide investment advice to investors do not need to registered with SEC or FINRA as long as the advice is incidental to the legal opinion. It is important to conduct the independent research.

Due Diligence Report

Does the project have the "due diligence report"? The broker/adviser may not just rely on the project promoter for information. Instead, the broker must check the statements and claims about the investment. This report should outline how the broker evaluated the venture's prospects and claims.

Registered Broker/Dealer

The person recommending a financial product to the investors should be a registered broker/dealer, either as registered as a broker with the SEC and must be a member of the Financial Industry Regulatory Authority, or FINRA. Investor can find out if someone is registered and obtain information about a registered broker by visiting FINRA's Broker Check website or calling FINRA's Broker Check hotline at (800) 289-9999.

For a registered investment adviser, the investor may be able to obtain information about the adviser by visiting the SEC's Investment Adviser Public Disclosure (IAPD) website.

Track Record

It is always important to consider if the project principal has a track record of running similar business. Part of the due diligence is to find out whether the project has prior history of selling similar offerings and if those offerings failed.

Brokers' Prior Relationships with the Project

Does the broker or adviser have a relationship with the promoter of the venture, or otherwise has a personal stake in the transaction? If the broker/adviser has a business relationship with the securities issuers, there may be potential conflict of interests. The investors should be aware of the prior relationship the extent of their business together, and any personal incentive in the offering. These or similar questions should help alert investors to any potential conflicts and biases that may exist in recommending the particular offering.


[1] The Investor Alert on the SEC official website: http://investor.gov/news-alerts/investor-alerts/investor-alert-private-oil-gas-offerings

[2] U.S. SECURITIES AND EXCHANGE COMMISSION: Litigation Release No. 21031 / May 8, 2009 Securities and Exchange Commission v. Hartmut Theodor Rose and James Patrick Reedy, Civ. Action No. 3:09-cv-00857-G (United States District Court for the Northern District of Texas, Dallas Division)

[3] U.S. SECURITIES AND EXCHANGE COMMISSION, Litigation Release No. 21040 / May 15, 2009 SEC v. Wellco Energy, LLC, Justin William Rifkin, Patrick V. Looper, Richard G. Pacheco, and Dustin D. White, (United States District Court for the District of Colorado, Civil Action No. 09-cv-01114-MSK-KLM)

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