The Practical Implications of the JOBS Act for EB-5 Capital Raises
On March 22, 2012 in Washington, DC, the "Jumpstart Our Business Startups" ("JOBS") Act was passed by the Senate, following its passage on March 8, 2012 by the House of Representatives. President Obama signed the JOBS Act into law on April 5, 2012.
The purpose of this legislation is to ease the regulatory burden on small companies that are in the process of raising capital. This article provides a general analysis of what the new law means to the EB-5 industry.
One immediate misunderstanding is that the JOBS Act gives a regional center (or other EB5 practitioner) a green light to ignore that SEC lawyer's rantings! Do regional centers no longer need to comply with the securities laws? While the JOBS Act does give the regional center more leeway to market EB-5 securities, it does not exclude regional centers and the principals of EB-5 projects from continuing to comply with securities law. This article focuses on the practical implications of the JOBS Act for regional centers and other EB-5 participants.EB-5 and Securities Law Before the JOBS Act
When you approach an investor to invest in your EB-5 project, you are engaged in the offer and sale of securities. This activity is regulated by state and federal securities laws, including the Securities Act of 1933 ("'33 Act"), which focuses on the offering and sale of securities, and the Exchange Act of 1934 ("'34 Act"), which addresses, among other things, the actions of issuers and broker-dealers in connection with selling securities.
A general misconception we have heard from companies seeking to raise money via the EB-5 Program is that securities law compliance should be a low priority. One EB-5 blogger even commented that the general attitude towards the securities laws within EB-5 community is: "We will pay attention to the SEC when they come knocking on the door." No doubt companies with this attitude are unaware that they are placing the funds they raise via EB5 at risk of forfeiture to the SEC and/or recovery by their investors.
The '33 Act requires that ALL offerings of securities be registered with the Securities & Exchange Commission (the "SEC"), UNLESS the offerings can be made pursuant to an exemption from registration. Registration is an expensive, time consuming process that imposes costly ongoing reporting requirements on issuers of securities. Most EB-5 projects (and in fact most companies that raise funds by selling securities) rely on exemptions to avoid registration. The most common exemption from registration under the '33 Act is set forth in Regulation D, which many issuers rely upon, including EB5 issuers. Regulation D outlines the rules for small private offerings. In addition to Regulation D, EB5 issuers are also able to take advantage of Regulation S, which is an exemption for exclusively overseas offerings. It is possible to rely on more than one exemption, which is common practice in EB5 issuances. Attempting to meet the criteria for two exemptions provides an EB5 issuer with a "back-up plan" in case the requirements for one of the exemptions are inadvertently violated or unsatisfied.
Regulation D consists of several sub-exemptions based on the number of investors and the amount of the offering. An offering under Rule 506 of Regulation D is the most flexible, allowing an unlimited amount of "accredited investors" to participate in the offering (and 35 unaccredited investors, though it is not a good idea to sell to any unaccredited investors), with no limit on the amount of capital raised. Generally speaking, an accredited investor has annual income greater than $200,000 (or $300,000 with his or her spouse) or a net worth over $1 million, not including his or her principal residence. Issuers relying on the Regulation D exemption could not engage in any general solicitations and advertising related to their issuance.
Under Regulation S, there is no prohibition on general solicitations, per se, however there can be no "directed selling efforts" in the United States and the securities cannot be sold to any "US Persons." Regional centers typically utilize overseas brokers' who can engage in solicitation activities abroad, however none of these activities can spill into the United States and the actions of these broker dealers are subject to the registration and anti-fraud provisions of the '34 Act, to be discussed later in this article.Understanding the JOBS Act
The JOBS Act is actually a collection of six separate Acts that are categorized under the JOBS Act as "Titles." These Titles were promulgated to collectively ease the restrictions on the capital raising activities of small companies. The provisions of the six Titles set forth in the JOBS Act are generally summarized below.Title I - Reopening American Capital Markets to Emerging Growth Companies Act
This Act, dubbed the "IPO On-Ramp" by securities practitioners, facilitates and simplifies the registration rules and processes in connection with an initial public offering (IPO) for a newly created category of company. This new category is referred to as an "emerging growth company" and is generally defined as an issuer with total gross revenue of less than $1 billion dollars. Because EB-5 projects are exclusively conducted as private offerings, this Title does not affect the existing EB-5 industry, until some adventurers decide to take on the challenge of completing an IPO. Registering one's securities publically entails ongoing reporting requirements for both the issuer (including the need to produce audited financials) and its principals, so it is doubtful that an EB5 practitioner will consider entering the IPO On-Ramp in the near future.
Title II - Access to Capital for Job Creators Act
Title II of the JOBS Act (along with Title V) may be the most relevant for EB-5 projects. Title II provides a loosening of the rule prohibiting general solicitation and advertising for Regulation D offerings. This new rule makes the prohibition on general solicitation inapplicable to Rule 506 offerings, so EB5 issuers relying on Rule 506 of Regulation D will be allowed to market their offerings to the general public. One word of caution: remember that Regulation S requires that no sales efforts be directed within the United States. Therefore, you should not be marketing your EB5 projects via any website or program that can be accessed or viewed in the United States. You should discuss any general solicitation plans with your securities attorney.
The removal of the general solicitation restriction mandates that all investors in the Rule 506 offering be accredited. Furthermore, the JOBS Act requires issuers to take "reasonable steps" to verify that the investor is actually accredited. Presently EB-5 practitioners rely on investors' suitability questionnaires -- an informal "check the box" self-reporting system. The SEC has not yet provided guidance on the implementation of the new rules, so it is not clear if the present form of "check the box" suitability questionnaire will meet the "reasonable steps" requirement. Investors may be required to provide additional information on future suitability questionnaires. EB-5 issuers should continue to obtain representation and warranties from their investors regarding accreditation and other matters as the solicitation proceeds.Title III - Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012'' or the ''CROWDFUND Act''
This Title is referred to as the "Crowdfunding" exemption. Title III permits securities registration exemptions for raising capital in small amounts from large numbers of individuals via the internet, including social media websites. The key provisions of Title III are:
This section is not particularly relevant to the EB-5 industry, because investors must invest a minimum of $500,000 for EB5 projects in TEA areas and $1,000,000 for EB5 projects in non-TEA areas. These amounts are well over the $100,000 cap imposed by Title III. Therefore an EB5 issuer could only utilize crowdfunding as an alternate source of non-EB5 capital.Title IV - Small Company Capital Formation Act
This Title amends Regulation A of the '33 Act. Regulation A allows a small company to offer shares to the public in a general solicitation, without satisfying all of the onerous requirements of a normal IPO. Title IV increases the amount of capital which can be raised under Regulation A from $5 million to $50 million US dollars. Under the current federal law, all securities offered under Regulation A can be freely resold and transferred.
Again, the applicability of Title IV to the EB5 industry is limited. With the easing of the Regulation D to allow for general solicitations, the main distinction between Regulation A and Regulation D is that Regulation D shares are not freely transferable. Given the very specific nature of an EB5 security, and the fact that EB5 issuers promise EB5 investors very little return after the return of principal, it is doubtful that a non-EB5 investor would be interested in an EB5 security. Furthermore, under immigration rules, the EB5 investor cannot transfer the investment until after his or her I-829 is adjudicated.
EB-5 issuers considering a Regulation A offering due to its loosened rules on the transferability of the securities and the fact that there is no prohibition on general solicitation should keep in mind that an offering circular more expansive than a Regulation D private placement memorandum is required. Furthermore, after registration, Regulation A mandates ongoing disclosure requirements, including annual audited financials.Title V- Private Company Flexibility and Growth Act
This Title also has significant consequences for the EB5 industry. Prior to the JOBS Act, the '34 Act required an issuer with more than $10 million in assets AND whose securities are held by 500 or more holders to register with the SEC. The registration requires onerous disclosure documents. The issuer must also file annual and quarterly statements with the SEC, as well as issue reports whenever any positive or negative newsworthy events occur. In addition, certain principals of the company are also subject to reporting obligations. Therefore, to avoid the registration requirement under the '34 Act, no EB-5 project to date has had more than 499 investors. Since most EB5 projects are located in targeted employment areas which allow for an investment amount of $500,000, the de facto limit on EB5 capital raises has been $249,500,000.
As a result of Title V, the threshold on the number of securities holders requiring a company to undergo SEC registration has been raised from 500 to 2,000, so long as not more than 499 shareholders are unaccredited. Assuming an EB5 issuer does not sell to any unaccredited investors, an EB5 capital raise for a project in a TEA area can now reach almost $1 billion before mandatory registration occurs. This makes it possible for much larger projects to avail themselves of EB5 capital.Title VI - Capital Expansion Act
This section has a similar effect to Title V, but it applies to banks and bank holding companies. Accordingly, it is inapplicable to EB5 offerings.What Remains the Same in Securities Law Compliance Despite the JOBS Act?
Despite some relaxation in the marketing of securities and the increase in the maximum amount which can be raised, EB-5 issuers should note that neither the Anti-Fraud Provisions nor Potential Broker-Dealer Liability issues have changed.The Anti-Fraud Provisions
The SEC's requirements that issuers provide "full and fair disclosure" in compliance with Rule 10(b)(5) under '34 Act remains in full force and effect. What does "full and fair disclosure" require? Issuers must provide disclosure to potential investors prior to their investment decision of all "material facts" that a "reasonably prudent person" would consider important in making an investment decision. In addition, the issuer must not omit to disclosure any material facts.
It is due to liability under Rule 10(b)(5) that creates the need for an EB5 issuer to deliver a Private Placement Memorandum (PPM) to all potential investors. This PPM must not only be truthful, but it must be "complete" in terms of describing all material information about the issuer and the project. In addition, because this financing is being effectuated via EB5, facts and circumstances about the EB5 Program and relevant immigration laws must also be disclosed and discussed in the PPM. Other key facts, such as the various entities and managers involved with your project and the regional center overseeing the project should also be described and any inter-relationships and potential conflicts of interest should also be disclosed.
The circumstances of failing to accurately and adequately disclose all material facts regarding an EB5 capital raise in a PPM can be severe. The SEC has very broad powers to insure that all investors purchasing securities can do so based on adequate information. The SEC can issue cease and desist orders, launch investigations, file injunctions, compel appearances by principals and witnesses, and issue civil and criminal fines and penalties. The penalties vary from $5,000 to $500,000 or can equal the gross amount of pecuniary gain to the issuer as a result of the violation.
Furthermore, the SEC also has expansive power to criminally prosecute any person who willfully violates its rules and regulations, including 10(b)(5). Upon conviction of an SEC violation, a person can be fined up to$10,000 or imprisoned up to five years, or both.
Finally, the securities laws give investors who may have been provided with an inaccurate or inadequate PPM a private cause of action to sue in either state or Federal court. These investors can recover the entire purchase price of the security, with interest - essentially giving them the right to recapture their entire subscription amount.Unregistered Broker/Dealer Liability
Federal securities regulation states that it is unlawful for any broker or dealer to "effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security" unless that broker or dealer is registered with the SEC. EB-5 issuers are still prohibited from utilizing unregistered brokers to solicit investors. Any third party (even an attorney) who introduces investors to a regional center marketing an EB-5 offering and receives transaction based compensation, is regarded as a broker-dealer who must be registered with the SEC.
Some regional centers simply label their unregistered broker as an "investor finder," however this will not shield them from liability. If a third party participates in important parts of the securities transaction, including solicitation, negotiation, or execution of the transaction and/or receives compensation based on the number of investors he brings into the offering, it is likely that he will be regarded as a broker. A legitimate "investor finder" merely introduces a potential investor to the regional center in exchange for a fee that is not contingent on whether that investor ultimately invests in the EB5 offering.
All registered broker/dealers should be located on the Financial Industry Regulatory Authority ("FINRA") website. FINRA is the largest independent regulator for all registered broker and brokerage firms. In addition, some states also require registration of broker/dealers.
There are adverse legal consequences for unregistered broker/dealers engaged in the sale of securities as well as for the EB5 issuer. The unregistered broker/dealer could be subject to injunctive or disciplinary action, the prohibition of such person or company from registering as a broker-dealer in the future, and exposure to investor suits, fines, and penalties, and even criminal prosecution. An EB-5 issuer utilizing an unregistered broker/dealer could be subject to fines, investor suits and possibly criminal prosecution. In addition, the SEC could subject such EB5 issuers to increased scrutiny of future securities offerings.In Conclusion
The JOBS Act expands the marketing opportunities and the investment limits for small companies in regards to raising capital. This is good news for the EB-5 community. However, as projects and deal structures grow ever-more complicated, securities compliance will be even more important in EB-5 capital raises.
For large scale investment projects, an EB5 issuer may one day consider registering with the SEC in order to access more investment options for its securities holders/investors. The fierce competition and ever changing legal regime also mandate higher standards for EB-5 attorneys. EB-5 legal practice not only requires the comprehensive understanding of all relevant immigration laws, it also increasingly requires a comprehensive understanding of the economic impact of each project, securities law, corporate law, and financial due diligence. The ultimate goal of any EB5 attorney should be to advise regional centers and other EB5 participants on how to build a long lasting reputation and manage successful projects.
This article is a very general summary of many complex securities law issues. No legal advice is provided in this article. Please consult your own professional advisors for advice applicable to your particular circumstances.
Yi Song, Esq. is an associate attorney at Mona Shah & Associates. Mona Shah & Associates is highly regarded in the EB5 field and has assisted my Regional Centers in navigating this complex, nuanced and constantly changing area of immigration law.
Clem Turner, Esq., is a business and corporate attorney and is the managing shareholder of the New York office of Homeier & Law, P.C. Homeier & Law is one of the premiere law firms handling EB5 corporate and securities matters, having represented regional centers and developers in numerous EB5 capital raises totaling over $1 billion in the aggregate.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.