The EB-5 visa is eligible to immigrants who make investments that create jobs for the American economy. “Regional centers” seeking investors for their EB-5 projects need to understand that raising capital from investors likely involves issuing securities to those investors, and such programs are therefore subject to stringent securities laws. This article provides a general overview of some of the securities laws that may affect regional centers engaged in raising capital for their EB-5 projects and a discussion of two popular exemptions from the securities laws that might be available to help facilitate the entire process.
Any discussion of securities laws should start with an understanding of what constitutes a “security”. The definition is typically extremely broad, and though it varies depending on whether one is looking at the federal or state laws governing the securities area, the basics are usually the same. It has long been understood that stocks or bonds of a company are securities. What many people don’t realize is that a whole myriad of other things can be considered securities. For example, promissory notes, or even investments in orange groves and chinchillas, have been considered securities. Generally speaking, regional centers soliciting investors for limited partnership interests, limited liability company interests, or other corporate entities are issuing securities.
In the United States, there are both federal and state laws that concurrently govern the sale of securities. The Securities Act of 1933, otherwise commonly referred to as the “Securities Act”, is the starting point for federal securities regulation for regional centers issuing securities. Each state also has its own version of securities laws which are commonly referred to as “blue sky” laws. The bottom line is that if one is selling securities or offering to sell securities, one must simultaneously comply with both federal law as well as the relevant state blue sky laws. Depending on the type of securities being issued, there may be additional laws, rules, or regulations that apply as well. Regional centers should consult local attorneys for advice ensuring compliance with local laws. Note, in particular, that offers of securities may be improper, even if no sale is made. That means the simple act of asking someone to buy securities could be illegal, even if the actual sale is never completed. Failure to comply with the securities laws could result in serious adverse consequences, including investor suits, fines and penalties, and even criminal prosecution.
Securities laws exist to protect investors. According to the Securities Exchange Commission (“SEC”) website at the time of this article, the two basic objectives of the Securities Act are to (1) “require that investors receive financial and other significant information concerning securities being offered for public sale”; and (2) “prohibit deceit, misrepresentations, and other fraud in the sale of securities”. The objectives for the state blue sky laws are typically similar.
To address the first basic objective of providing material and accurate information to investors, the Securities Act and blue sky laws generally provide that any offer to sell securities must first be either registered or qualified with the appropriate governmental body or satisfy an available exemption.
The process of registration or qualification can be an extremely trying process involving much expense and time. Consequentially, most issuers opt not to register or qualify the securities they plan to offer or sell and seek an exemption instead. Remember, a regional center must seek an exemption for all securities laws that affect it. For example, a California regional center that sells securities to investors from New York, Louisiana, and Texas would be subject to the state laws of New York, Louisiana, Texas, and California as well as federal laws and would need to find applicable exemptions under all such laws to avoid the need to register or qualify its securities offering. Since regional centers generally only seek and accept funds from foreign investors, compliance with multiple state laws often does not pose significant issues. However, compliance with the blue sky laws of a “home state” is always a requirement, as is compliance with federal law.
In the EB-5 regional center space, the two most common securities exemptions relied upon are Rule 506 of Regulation D (“Reg D”) and Regulation S (“Reg S”).
Reg D actually contains three rules (Rule 504, Rule 505, and Rule 506) providing differing exemptions from the registration requirements; however, due to the economic realities affecting EB-5 regional centers, Rule 506 is the primary rule relied upon. Rule 506 offerings have an added advantage in the sense that regional centers that offer securities under Rule 506 may avoid having to register or qualify the securities under state laws. Under the National Securities Markets Improvement Act of 1996, state securities registration requirements for securities offered pursuant to the provisions of Rule 506 are preempted by federal law. In other words, regional centers that offer securities under the exemption afforded by Rule 506 are also exempted from registration under the various state blue sky laws.
In reality, Rule 506 of Regulation D is not the actual exemption itself. Rather, Rule 506 is a “safe harbor” in the sense that compliance with its conditions affords a regional center comfort that it can rely on the underlying exemption, which in this case is Section 4(2) of the Securities Act. Section 4(2) provides a seemingly broad exemption for “transactions by an issuer not involving any public offering”. Since the precise limits of this exemption are somewhat uncertain, Rule 506 was promulgated to give assurance to companies that they would be within the Section 4(2) exemption so long as they satisfied certain requirements. Even though exempt from registration, companies using the Rule 506 exemption must still file a Form D notice with the SEC describing the transaction.
In order for an offering to rely on the Rule 506 exemption, certain criteria must be met, which generally include: (1) limitations on general solicitation or advertising used to market the securities (e.g., no radio shows, newspaper advertisements, or seminars to the public) in the case of Rule 506(b) offerings (no such limitation for Rule 506(c) offerings); (2) requirements on the type of investors permitted (e.g., only accredited investors allowed in Rule 506(c) offerings); (3) a cap on the number of certain types of investors (e.g., no more than 35 unaccredited investors allowed in a Rule 506(b) offering); (4) disclosure obligations that vary based on the type of investors solicited (e.g., significant disclosure obligations if soliciting unaccredited investors); (5) significant restrictions on transferability of the securities being issued (generally includes minimum hold periods at the very least); and (6) filing of a Form D notice with the SEC. As indicated before, compliance with state blue sky laws may require notice filing in the applicable states and payment of certain fees.
The “Jumpstart Our Business Startups Act”, also known as the “JOBS Act”, was signed into law by President Obama on April 5, 2012. Among other things, such as increasing the number of owners (e.g., shareholders, members, limited partners) a company may have before being required to register its ownership interests (e.g., common stock, membership interests, limited partner interests) with the SEC and become a publicly reporting company, the JOBS Act lifts the current ban on general solicitation and advertising in Rule 506 offerings sold exclusively to accredited investors. On September 23, 2013, the SEC adopted Title II of the JOBS Act as Rule 506(c) of Regulation D. As required by the JOBS Act, Rule 506(c) eliminates the prohibition against general solicitation and general advertising with respect to offers and sales of securities made pursuant to Rule 506(c), provided that all purchasers are “accredited investors.” In exchange for the right to generally solicit and advertise, issuers are obligated to take SEC prescribed “reasonable steps” to verify that the purchasers of the securities are “accredited investors”.
Reg S is entirely different in its approach than Reg D. Essentially, Reg S exempts offers and sales of securities “that occur outside the United States” from Section 5 of the Securities Act, which contains the principal obligations for issuers to register securities under federal law. Note that Reg S does not address blue sky or foreign laws, so a regional center would still have to address those issues and comply with such laws.
An offer or sale of securities is deemed to occur outside the United States if (1) it is made in an offshore transaction; (2) it is made without any directed selling efforts in the United States; and (3) it meets certain other conditions, depending on what category (Category 1, 2, 3) under Rule 903(b) of Reg S apply to the securities being issued. Most regional centers issue “Category 3” securities, which are subject to the most conditions.
Though Reg S seems to set forth the conditions quite simply, one must carefully review the definitions for certain terms, such as “distribution compliance period, “offshore transaction”, “directed selling efforts”, “offering restrictions”, “U.S. person”, and others, as those definitions provide crucial guidance in interpreting the rules governing Reg S. One benefit of Reg S is that unlike Reg D, it does not require filing of any notice with the SEC in order for it to be available as an exemption.
A regional center relying primarily on the Reg S exemption may also concurrently utilize other available exemptions. A regional center may choose to conduct an offering using multiple exemptions because one exemption does not cover all the investors the regional center plans to seek or because it desires to have a backup exemption in case its primary exemption fails. This allows for a regional center to conduct offerings under multiple exemptions, such as a simultaneous offering under both Rule 506 and Reg S. Careful attention must be paid to the method of offering and sale of the securities to make sure that the regional center is in compliance with all of the conditions of each exemption it hopes to rely upon.
Compliance with the requirements of Rule 506 and Reg S is extremely important. While some mistakes may not jeopardize a regional center’s ability to rely on the claimed exemptions, others may invalidate the regional center’s ability to do so. If the criteria permitting reliance upon the exemptions provided under Rule 506 or Reg S are not satisfied, a regional center would have to register or qualify the securities in order to legally sell them unless the regional center was able to find alternative exemptions. Again, that process of registration or qualification will generally be much more painful and expensive than simply finding an exemption. In the case of regional centers, registration or qualification of securities would be impractical due to cost, timing, and other factors. Beware that regional centers avoiding registration or qualification of securities at the state level due to reliance on Rule 506 and that Rule’s preemption of state securities laws would, in the case of failure to qualify for the Rule 506 exemption, also have to either register the securities in all applicable states or find available exemptions in each one.
The second objective of the securities laws highlighted by the SEC is to “prohibit deceit, misrepresentations, and other fraud in the sale of securities”. Generally, both the federal and state securities laws address this objective by prohibiting a misstatement or omission of a material fact in connection with an offering of securities. Neither Rule 506 nor Reg S exempts securities offerings from the anti-fraud provisions of the various securities laws. The regional center, and its key persons, can become subject to civil and, in severe cases, criminal liability for violations of these anti-fraud provisions. Though the mandate to disclose information in a non-fraudulent manner seems simple, determining what is “material”, and therefore must be disclosed accurately, can be difficult. Generally speaking, something is considered material if there is a substantial likelihood that a reasonable investor would consider the fact to be important in deciding whether or not to invest.
The EB-5 regional center program is an exciting mechanism for promoting investment in the American economy and the creation of jobs while providing qualified immigrants with a chance to obtain a green card in the United States. Nevertheless, regional centers must be aware of U.S. federal and state laws affecting securities offerings and take proper steps to comply with those that apply to them, as the cost of failing to do so could be catastrophic. There exist definite strategies for regional centers to minimize their exposure to liability from securities-related claims, whether those claims arise from government, or investors. Regional centers should carefully control the securities offering process, including exercising careful oversight of those parties conducting and/or assisting with the offering, to ensure a successful and legal EB-5 capital raise.
Summary of Exemptions Under Rule 506 & Reg S
|Amount that may be raised
|No limit||No limit|
|Number of investors allowed
|No limit on accredited investors, but in 506(b) offering, only up to 35 unaccredited investors allowed;||No limit|
|For 506(b), unaccredited investors must be sophisticated; For 506(c), only verified accredited investors allowed||None|
|No disclosures required for accredited investors; Detailed disclosures required if investors include unaccredited investors||None, other than legends
|Form D, filed electronically, within 15 days of first sale of the securities in an offering||None|
|General solicitation and advertising
|Prohibited with 506(b) offerings as they must be private; Allowed with 506(c) offerings||Permitted so long as no “directed selling efforts” are made in the United States|
|State securities laws
|Preempts state securities laws, but states are permitted to require notice filings and charge a fee||Must register/qualify securities with applicable states or find an exemption|
 Anti-fraud provisions of various securities laws still apply.
 Note, however, that the preemption does not affect all types of securities or all types of person. Additionally, while an issuer may not have to register or qualify the securities under the various states’ blue sky laws, it may still be required by some states to pay certain fees and make notice filings.