On March 22, 2012 Washington, DC, "Jumpstart Our Business Startups" (JOBS) Act was passed by the Senate, following its passage on March 8, 2012 by the House of Representatives.
The purpose of the said legislation is to ease the regulatory burden on small companies for raising capital. This article provides an in-depth analysis of what the new law means to the EB-5 world and to regional centers.
One immediate misunderstanding is that the JOBS Act gives a regional center a green light to go ahead and ignore that SEC lawyer's rantings! Do regional centers indeed no longer need to comply with the securities law? The truth is that the JOBS Act gives the regional center more leeway to market EB-5 securities. However it does not exclude the regional center and the EB-5 projects from continuing to comply with the securities law. This article focuses on the practical implications for the JOBS Act for the regional center and EB-5 Projects.
Understanding the JOBS Act
The JOBS Act consists of six separate Titles. These different proposals are to address the issue of easing restrictions on capital raising activities of small companies.
Title I - Reopening American Capital Markets to Emerging Growth Companies Act
It is designed to facilitate the initial public offering (IPO) for a new category of companies called "emerging growth company", an issuer with total gross revenue of less than $ 1 billion US dollars. To such companies to conduct an IPO, the JOBS Act simplifies that registration process. So far almost all EB-5 projects conduct private offerings exclusively, this Title does not affect the existing EB-5 world, until some adventurers decide to take on the challenge of complete an IPO.
Title II - Access to Capital for Job Creators Act
The author believes that Title II of the JOBS Act is the most relevant for EB-5 projects. This section provides a loosening of the rule on general solicitation and advertising rules for EB-5 offerings. This new rule makes Rule 502 prohibition on general solicitation inapplicable to Rule 506 small and private offering.
For a project to be qualified under this exemption the investors must be accredited. Under Rule 501 under Regulation D, "the accredited investor" is defined as:
One of the noticeable changes of the new rule under JOBS Act is it requires the issuers to take "reasonable steps" to verify that the investor is actually "accredited". Presently the regional center and other stand-alone EB-5 projects conduct the process through investors' suitability questionnaires, or a loose internal self-reporting system.
Without specific SEC guidance on implementation of the new rules, it is hard to predict whether such practice is sufficient to satisfy the "reasonable step" requirement. It is highly recommendable that the regional center and the EB-5 projects should continue to obtain representation and warranties from the investors as the solicitation proceeds.
Title III - Entrepreneur Access to Capital Act
This section permits securities registration exemptions for raising capital in small amounts from large numbers of individuals via internet social media. The specific requirement under Title III is:
This section is the least relevant to the EB-5 context, because the obvious minimum capital investment requirement is $500,000 for TEA areas and $1,000,000 or non-TEA areas. However, for the sake of a complete elaboration of the JOBS Act, the author feels this section should not be omitted.
Title IV - Small Company Capital Formation Act
This section permits a public offering to have a relatively simple and inexpensive registration process, if the amounts of capital are limited; if up to $50 million US dollars is raised the company qualifies under the Regulation A exemption. Regulation A permits the securities purchased by the investor to be transferrable. Under the current federal law, all securities offered under Regulation A can be freely resold and transferred. Another advantage of this section is that the solicitation and general advertising is not prohibited.
The author believes this section will bring delightful changes to the EB-5 community. Currently the overwhelming majority of EB-5 projects claim Regulation D exemption for registration. Thus there is a significant limitation on the manner of offer and resale. Rule 502(c) under Regulation D prohibits a general solicitation. Rule 502(d) prohibits the resale of securities.
Since this section of the JOBS Act increase the offering ceiling to $50 million ($5 million under the former Regulation A) though with registration process, significantly simplified compared to the regular registration process, some EB-5 issuers may choose to opt for the Regulation A offering simply for its loosened rules on the transferability of the securities and the fact that there is no prohibition on general solicitation.
Title V - Private Company Flexibility and Growth Act
The current federal securities law requires an issuer with more than $10 million in assets AND whose securities are held by 500 or more owners to register with the SEC. The registration requires the issuer to conduct periodic reporting and certain reporting of the individual owners. That means if an EB-5 project satisfies the $10 million in assets requirement at the same time, it solicitants more than 500 (inclusive) investors, it must registered with the SEC. In other words, to avoid the registration requirement under this provision the EB-5 project can have a maximum of 499 investors and to raise $ 249,500,000 from the capital market.
Title VI - Capital Expansion Act
This section has similar effect with Title V, but it applies to banks and bank holding companies with different standards.
EB-5 and Securities Law Before the JOBS Act
To obtain a potential investor for an EB-5 project, either for a project company or an EB-5 regional center, is essentially the sale of securities. This activity is regulated by the federal securities law, namely the Securities Act of 1933, which focuses on the offering and the sales of the securities, and the Securities Exchange Act of 1934, which focuses on the selling the securities by the broker-dealers.
The general misconception in the EB-5 practice is that securities law is the last thing the project should pay attention to. One EB-5 blogger even commented that the general attitude towards securities law within EB-5 community is: "we will pay attention to the SEC when they come knocking on the door."
The securities law requires that the offering of securities be registered with the Securities & Exchange Commission (the "SEC"). Most EB-5 projects are exempted from registration under Regulation D. Regulation D covers the small offering and the private offering. Regulation S is for exclusive overseas offerings.
Regulation D consists of sub-exemptions, such as Rule 506 and manages an offering that is no more than (or the issuer reasonably believes that there are no more than) 35 purchasers of securities from the issuer in any offering. There is no restriction on the dollar size amount under Rule 506.
Another provision under Regulation D is Rule 502. Rule 502 governs general solicitation or advertising to openly market the securities. General solicitation or advertising are defined as including but not limited to:
Because the Regulation D permits "private offering" to be exempted from registration, any "general solicitation" defeats the spirit of the law. However, the issuers can claim a "pre-existing relationship" between themselves and the investors. Other regional centers utilize overseas brokers' own solicitation activities to avoid "general solicitation" on the part of the issuers defined under the federal securities law. This rule applies to conduct in the United States and abroad.
What Remains the Same in Securities Law Compliance Despite the JOBS Act?
The regional center and the EB-5 projects shall note that neither the Anti-Fraud provisions nor the Potential Broker-Dealer Liability provisions have changed, despite the passage of the JOBS Act. Even though the rule on general solicitation is significantly expanded the marketing opportunities, during the process of the solicitation, the project still needs to provide "full and fair disclosure" in compliance with the section 10(b) under securities law.
What is "the full and fair disclosure"? It requires the issuers to provide disclosure to potential investors prior to the investment decision of all "material facts", that a reasonably prudent person would consider important in making an investment decision, and the issuer must not omit to disclosure any material facts. Failure to meet this disclosure standard constitutes fraud.
Unregistered Broker/Dealer Liability
Repealing the general solicitation rule does not negate the potential broker-dealer liability and possible rescission. The federal securities regulation states 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. Regional center and EB-5 projects are still prohibited from utilizing unregistered brokers to solicit investors. If a third party who introduced investors to the regional center and EB-5 project and receives transaction based compensation, including some attorneys who make the "introduction", such party is regarded as a broker-dealer.
The law regulates conduct and activities of the broker/dealer, not labels. Some regional centers simply label their unregistered agent as an "investor finder", which does not completely shield them from liability. 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.
Similarly the prohibition of selling securities through unregistered agents rule is also reflected in some state securities law. The state securities law regulate broker/dealer is generally referred as "blue sky laws". The regional center or EB-5 projects are prohibited to use unregistered broker/dealer. Any sales of securities conducted by unregistered broker/dealer shall be disclosed to the investors. Failure to do so constitutes a failure to disclose material information.
According to New York Securities Act Rule 352.C.1(c), any false representation made regarding engaging in to induce or promote the issuance, distribution, exchange, sale, negotiation or purchase within or from this state or any securities or commodities, when the party made such representation could have known the truth with reasonable effort, or made no reasonable effort to ascertain the truth, or did not have knowledge concerning the representation or statement made.
There are adverse legal consequences for unregistered broker/dealers engaged in the sale of securities as well as for the regional center. 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. If a regional center or stand-alone EB-5 project utilizing the unregistered broker/dealer, they could be subject to investor suits and possibly criminal prosecution, increased scrutiny of the regional center and its securities offerings.
The JOBS Act expands the marketing opportunities for small companies in regards to raising capital. It is good news for the EB-5 communities. As the projects and deal structures grow ever-more complicated, the securities compliance by no means loosens in the field of EB-5 practice.
For large scale investment projects and the regional center, it is not surprising if an RC consider long term development and eventually actually register with the SEC because it provides more investment options for the securities holders/investors. The author believes that the fierce competition and the ever changing legal regime also raise standards for EB-5 attorneys. EB-5 practice not only requires the mere understanding of the relevant immigration laws, it also increasingly requires a comprehensive understanding of the economic impact of each project, securities law, financial due diligence to be able to advise the regional center how to build a long lasting reputation and to manage successful projects.
Yi Song is an associate attorney at Mona Shah & Associates in New York City. Her practice focuses on EB-5 and securities law. She is a graduate of the Georgetown University Law Center.
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