How do the SEC Enforcement Actions Against Persons Receiving Finders Fees for EB-5 Investments Affect Chinese Marketing Agents?

By Catherine DeBono Holmes

On December 7, 2015, the U.S. Securities and Exchange Commission (SEC), the U.S. federal agency that administers the U.S. federal securities laws, announced a series of settlement orders against six lawyers across the U.S., one resident of China who formerly resided in the U.S., and one enforcement action against another U.S. attorney, all of whom were charged with offering EB-5 investments while not registered to act as securities brokers under U.S. securities laws.  Andrew J. Ceresney, Director of the SEC Enforcement Division, stated in the SEC's press release announcing the action that: "Individuals and entities performing certain services and receiving commissions must be registered to legally operate as securities brokers if they’re raising money for EB-5 projects. The lawyers in these cases allegedly received commissions for selling, recommending, and facilitating EB-5 investments, and they are being held accountable for disregarding the relevant securities laws and regulations." 

Unlike all of the other enforcement actions announced by the SEC in 2014 and earlier in 2015, none of the actions announced on December 7, 2015 involved fraud in connection with the EB-5 investments themselves, or any losses by investors who purchased EB-5 investments. The December settlement orders involved solely the receipt of payments which the SEC deemed to be commissions for sales of EB-5 investments. These settlement orders were the result of a wide-ranging investigation by the SEC over the past two years into the methods by which EB-5 investments are sold, and the persons who receive these payments. It should be noted that all of the persons named in the actions were U.S. persons at the time that they are alleged to have received payments. 

As of this date, no foreign marketing agent who has received payments in connection with the sale of EB-5 investments outside the U.S. has been charged with any violation of U.S. securities laws. However, the SEC announced in January 2016 that the EB-5 market is one of the SEC's examination priorities, indicating that the SEC will be specifically focusing on EB-5, and will likely seek to bring enforcement actions against persons whom the SEC believes are engaged in selling EB-5 investments in violation of U.S. securities laws. Therefore, it is critical for Chinese marketing agents to understand the requirements of U.S. securities laws and conduct their business in a way that does not result in violations of those U.S. laws.

The U.S. Exchange Act exempts non-U.S. persons from the requirements of the Exchange Act. 

Not everyone involved in selling EB-5 investments is required to be a U.S. registered securities broker-dealer. There are exemptions from registration that apply to a number of persons engaged in the EB-5 investment business, subject to meeting the conditions of each exemption.  By complying with the conditions of an exemption from registration, it is possible for non-registered persons to be engaged in the EB-5 investment business. This article explains the exemption from securities broker-dealer registration that is available to Chinese marketing agents, and the conditions required to claim this exemption.

The basis of the SEC's actions against unregistered persons for receiving finders fees is Section 15(a) of the U.S. Securities Exchange Act of 1934 (the "Exchange Act"), which requires that persons engaged in the business of transactions in securities are required to register with the SEC as securities broker-dealers. However, that section does not apply to transactions outside the U.S. according to Section 30(b) of the Exchange Act. That Section provides a general exemption from all provisions of the Exchange Act, including Section 15(a), for persons not transacting business in the U.S. It reads as follows:

"The provisions of this title or of any rule or regulation thereunder shall not apply to any person insofar as he transacts a business in securities without the jurisdiction of the U.S., unless he transacts such business in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate to prevent the evasion of this title."

U.S. Courts have narrowed the exemption for non-U.S. persons.

Read literally, Section 30(b) would exempt every person who transacts business outside the U.S. from any requirements under the Exchange Act. However, the U.S. courts have held that this exemption is not available under three circumstances:

(i) if transactions occurred in a U.S. securities market – which has generally been interpreted by the courts to mean transactions on U.S. stock exchanges or trading markets;

(ii) if offers and sales were made abroad to U.S. persons or in the U.S. to facilitate sales of securities abroad; or

(iii) if the U.S. was used as a base for securities fraud perpetrated on foreigners.

U.S. courts have allowed SEC jurisdiction over EB-5 investments sold outside the U.S. in cases of securities fraud.

In connection with EB-5 jurisdiction for actions occurring outside the U.S., the SEC and the U.S. courts have focused on cases involving securities fraud perpetrated on EB-5 investors. These fraud cases have typically involved regional centers or EB-5 investment sponsors who made false promises to investors regarding the project, or who raised funds for a designated project and then used the offering proceeds for their personal benefit, rather than investing the funds in the project. In many cases, this would have resulted in EB-5 investors not receiving I-526 approval, because their investment was not used for the project specified in their I-526 petitions, and in some cases the EB-5 investors' money was lost as well. 

For example, in 2015 the SEC brought an action for fraud against Lobsang Dargey and his “Path America” companies, which raised at least $125 million for two real estate projects but then diverted $14 million for unrelated real estate projects and $3 million for personal use including the purchase of his $2.5 million home and cash withdrawals at casinos. Earlier in 2015, the SEC brought an action for fraud against Bingqing Yang and Luca International Group, where the defendants diverted the proceeds for personal use. In the 2013 case against Marco A. Ramirez, the SEC alleged that the defendants misused investor funds for personal use such as funding their Cajun-themed restaurant.  

In the 2013 case, SEC v. A Chicago Convention Center, LLC, Anshoo Sethi, and Intercontinental Regional Center Trust of Chicago, LLC, a U.S. federal court ruled that the SEC had adequately alleged a domestic securities transaction, as required to state a securities fraud claim. The court in that case focused on the connections between the EB-5 investment offering and the U.S., including that the subscription agreement was required to be delivered by EB-5 investors to defendants in the U.S., the offering funds were sent to a U.S. based escrow agent, the escrow agent would only release funds upon approval of the investors' U.S. visa applications, and the investors were bound only if the subscription agreement was accepted and countersigned by the manager of the EB-5 investment fund in the U.S. The court found that these connections were enough for the SEC to assert jurisdiction over the case, since it involved securities fraud perpetrated on foreigners.   

The SEC generally does not require foreign persons to register as securities broker-dealers for sales of U.S. securities outside the U.S. to non-U.S. persons.

In cases that do not involve fraud or sales of securities in a U.S. market or to U.S. persons, the SEC's jurisdiction is more limited due to the general exemption of Section 30 of the Exchange Act. The SEC has recognized its more limited role in matters that do not involve fraud in several prior policy statements. For example, in SEC Release 34-25801 issued in June 23, 1988, the SEC stated that its policy is not to require broker-dealer registration where foreign firms sell U.S. securities exclusively to non-U.S. persons outside the U.S. In fact, the SEC specifically stated in Release 34-25801 that:

"[T]he staff believes that, in contrast to the more expansive scope of the antifraud provisions, the U.S. broker-dealer registration requirements were not intended to protect foreign persons dealing with foreign securities professionals outside the United States.  Rather, the primary responsibility for protecting foreign investors from wrongful conduct of foreign securities professionals properly lies with foreign securities regulators."

The SEC has also adopted regulations under the Exchange Act that recognize the role that non-U.S. selling agents can have in connection with sales of U.S. securities.  For example, in SEC Rule 15a-6, the SEC affirmed its policies on non-U.S. persons, and stated that U.S. broker-dealer registration is not required for overseas agents who sell securities solely to non-U.S. persons and conduct their selling activities entirely outside the U.S. 

In the SEC's adopting release for Rule 15a-6, the SEC stated that broker-dealers operating outside the physical boundaries of the U.S. but using the U.S. mails, wires or telephone lines to trade securities with U.S. persons located in the U.S. would not be generally exempt under Section 30(b) of the Exchange Act. However, the SEC affirmed its long standing policy that foreign broker-dealers who solicit non-U.S. persons outside the U.S. to purchase securities of U.S. issuers are not required to be registered as U.S. securities broker-dealers.

Chinese agents who wish to avoid violation of the Exchange Act should avoid doing business in the U.S. and avoid owning interests in U.S. Regional Centers and other U.S. Businesses.

Chinese agents who participate in the sale of EB-5 investments are, in effect, acting as non-U.S. broker-dealers of U.S. securities. Under the principals of SEC Rule 15a-6 and SEC Release 34-25801, Chinese agents would not be required to register under the Exchange Act so long as they conduct this business outside the U.S., and sell only to non-U.S. persons. The SEC typically considers where a business has offices, where it has employees, and where its employees are located when they are conducting business, in determining where a person is conducting business. Therefore, in order for Chinese agents to demonstrate that they are not conducting business in the U.S., it is strongly recommended that Chinese agents should have no U.S. office, no U.S. based employees or officers, and that Chinese agents do not solicit investors in the United States.

Some Chinese agents seek to obtain an equity ownership interest in U.S. regional centers, or in the entity that owns property in which EB-5 funds are being invested, or that loans funds to the EB-5 project. Holding those types of equity ownership investments in U.S. businesses might be considered evidence of doing business in the U.S., which could potentially subject Chinese agents to jurisdiction in the United States. There is no precedent for whether the SEC or a U.S. court would consider a passive equity ownership in one or more U.S. businesses by a Chinese agent to be doing business in the U.S. However, where the Chinese agent is actively raising money through an EB-5 offering for that entity, this may be considered a more active involvement by the Chinese agent in the U.S. business, which could open the possibility of jurisdiction in the U.S.

It is also unclear whether a Chinese agent would be considered to be doing business in the U.S. if the agent makes visits to the U.S. to conduct due diligence regarding U.S. projects, or it chaperones Chinese EB-5 investors to visit project sites and conduct their own due diligence. In our view, these are not the types of activities that should cause a Chinese marketing agent to lose its exemption from broker-dealer registration under U.S. securities laws. However, for those Chinese agents who wish to be as conservative as possible, we would advise that Chinese agents engage third parties to conduct due diligence on projects, and arrange for a representative of the EB-5 project sponsor to meet any prospective EB-5 investors who wish to visit a site. 

Attending periodic EB-5 conferences or other general business events in the U.S. should not be considered doing business in the U.S., as long as Chinese agents do not maintain permanent addresses in the U.S. An occasional visit to a project site would also likely not be considered doing business in the U.S. There are no specific guidelines or regulations regarding the type or number of visits that a Chinese agent can make to the U.S. without being considered to be doing business in the U.S.

Some Chinese marketing agents may own interests in U.S. regional centers, either completely or in partnership with U.S. persons. If a Chinese marketing agent conducts business on behalf of a U.S. regional center, that could be deemed to be doing business in the U.S., since the regional center is a U.S. based company. Therefore, Chinese marketing agents who conduct business as a representative of a U.S. regional center could lose their exemption from U.S. securities laws, even if all of their EB-5 investment solicitations are made in China.

Chinese agents may engage in the EB-5 investment business as agents of the EB-5 investment issuer (the "NCE") or as foreign associates or foreign finders hired by a U.S. company or U.S. securities broker-dealer.

Chinese agents may engage in the EB-5 investment business under written agreements entered into directly with the U.S. issuers of EB-5 investments. This is the most typical form of EB-5 marketing arrangement today. Under this arrangement, the issuer of EB-5 investments hires the Chinese agent and pays the Chinese agent directly. The issuer can legally agree to pay the Chinese agent, so long as the Chinese agent is not required to register as a U.S. securities broker-dealer. As previously explained, this requires that the Chinese agent have no U.S. offices, no U.S. employees, conduct no business in the U.S., and sell only to non-U.S persons outside the U.S.

Some EB-5 investment issuers hire U.S. registered securities broker-dealers to participate in their EB-5 investment offerings. Sometimes, these U.S. broker-dealers lead the entire EB-5 offering, including the offering outside the U.S. In those cases, the U.S. broker-dealer enters into agreements with Chinese agents under which the U.S. broker-dealer pays the Chinese agents.  These agreements are generally permitted under a policy announced by FINRA, which stands for Financial Industry Regulatory Authority, the organization that regulates U.S. registered securities brokers. FINRA allows U.S. securities broker-dealers to pay commissions to "foreign associates" of the broker dealer, or finder's fees to unregistered foreign finders. A foreign associate is an individual person who is registered with the broker-dealer by the filing of a Form U-4 for that individual. The U.S. securities broker-dealer is required to supervise all of the securities related activities of the foreign associate. U.S. securities broker-dealers can also pay "foreign finders," provided that they do no more than introduce investors to the U.S. securities broker-dealer, and do not participate in any way in the EB-5 investment transaction, such as by helping the investor fill out a subscription agreement.

The SEC has not indicated any changes in its policies towards Chinese agents who sell EB-5 investments outside the U.S.

As part of its investigation into the EB-5 investment market, the SEC has requested a number of EB-5 Regional Centers to identify all persons to whom they paid commissions or fees in connection with the sale of EB-5 investments. From the responses it has received from Regional Centers over the past two years, the SEC is aware that Chinese marketing agents are receiving commissions and other compensation in connection with the sale of EB-5 investments in China.  The SEC has not made any statements indicating that these commissions or other compensation are in violation of the Exchange Act with respect to Chinese marketing agents who do not conduct business in the U.S. Therefore, the recent actions announced by the SEC against persons who received finders' fees for sales of EB-5 investments should not impact the business of Chinese marketing agents, provided that they have no offices or employees in the U.S., do not solicit investors in the U.S., and do not do business in the U.S., either in connection with sales of EB-5 investments or as a representative of a U.S. regional center.

Catherine DeBono Holmes

Catherine DeBono Holmes

Catherine DeBono Holmes is the chair of the investment capital law group at Jeffer Mangels Butler & Mitchell LLP in Los Angeles, and has practiced law at JMBM for over 30 years. She specializes in EB-5 immigrant investment offerings and hotel and real estate transactions made by Chinese investors in the U.S.


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