It’s no secret that the Securities & Exchange Commission (SEC) has actively policed the EB-5 industry. Oversight by the SEC has generally been a good thing for the industry as it has brought greater awareness to legal compliance and helped protect investors who might have otherwise been defrauded. Historically, SEC actions have centered around claims of fraud or broker-dealer violations. There are signs, however, that they may bring other claims in the future.
In October 2016, at IIUSA’s 6th Annual EB-5 Industry Forum, SEC’s LA Regional Director, Michele Layne mentioned that they may be looking at registration violations. It was only mentioned once in a long presentation focused largely on other topics, and most of the conference attendees didn’t think about the significance of that comment. In June 2017, at a luncheon organized by the Federal Bar Association, SEC staffers from the enforcement division again noted that they are looking at registration violations. This time, however, they spent significantly more time addressing the topic. It makes sense for the SEC to enforce registration violations. The concept of registration or proper exemption therefrom is at the very heart of securities laws.
In fact, the SEC has previously taken action against unregistered EB-5 offerings. In the SEC’s enforcement action against Luca in July 2016, the SEC alleged that Luca did not properly have any securities exemptions. Luca claimed to rely on the Rule 505 & Rule 506(b) private offering exemptions, but the SEC argued that because Luca generally solicited and advertised its offering, the exemptions didn’t apply and therefore Luca was in violation of the laws for conducting an unregistered securities offering. Unfortunately, most of the EB-5 industry focused on the fraud claims in Luca and largely ignored the unregistered offering claims.
Registration & Exemptions
In general, securities offerings must be registered unless they are offered pursuant to a valid securities exemption. At the federal level, EB-5 capital raises have generally relied upon three primary securities exemptions: Rule 506(b) of Regulation D, Rule 506(c) of Regulation D, and Regulation S. In order to properly use those exemptions, specific criteria and guidelines must be followed. If they are not, then the offering would not be exempt and would require registration or another exemption. Unregistered offerings without a valid exemption from registration are illegal.
Broadly speaking, Rule 506(b) does not allow for general solicitation or advertising of the offering; in general, it is also targeted only at accredited investors although technically, with significantly increased compliance burdens, up to 35 non-accredited investors may be allowed. Rule 506(c) does allow for general solicitation and advertising of the offering (including to non-accredited investors), but requires that all investors be verified as accredited investors using SEC prescribed “reasonable steps”. Reg S generally requires that the offering only be made to non-US persons in offshore transactions. It is possible to have a single offering comply with both Reg D and Reg S, and it’s also possible to have separate Reg D and Reg S offerings at the same time.
Easy to Prove
Unlike fraud, which can be somewhat difficult to prove, registration violations are relatively easy to prove. If a company purported to rely on Rule 506(b), yet there was evidence of general solicitation or advertising, it would be relatively easy to demonstrate a registration violation. This was the case in Luca where they claimed private offering exemptions, but the SEC easily found signs of general solicitation and advertisements. If a company purported to rely on Reg S, yet there was evidence of them selling or promoting the sale of securities within the US or to a US resident, it would also be relatively easy to demonstrate a registration violation.
Avoiding SEC Enforcement
Issuers should check with their securities counsel to confirm that they are utilizing the proper securities exemptions and are operating within the confines of the securities exemptions. It’s important to review the offering documentation to ensure that it is consistent with the securities exemptions being relied upon. Equally important is to carefully analyze marketing practices, including third-parties who might be authorized to market the securities on the issuers behalf. It’s also a good idea to review marketing materials to ensure that they are legally compliant. Among the most crucial is to analyze websites for legal compliance. Websites should not have any information which could be deemed to be a general solicitation or advertising of an offering if the securities offering relies on the Rule 506(b) exemption. The offering should not be viewable by those in the US if the securities offering relies on the Reg S exemption.
While securities registration and exemptions are complicated, an experienced securities attorney should be able to navigate the waters. Look for a securities attorney that fully understands both Rule 506(b) of Regulation D as well as the newer, Rule 506(c) of Regulation D. Make sure the securities attorney understands Reg S, the interplay between Reg D and Reg S, and when Reg S doesn’t work. Although it’s a complex initial analysis, once it has been determined what exemptions are being utilized, compliance itself is relatively simple.