Emerging Trend: Broker-Dealer Participation in EB-5 Financing - EB5Investors.com

Emerging Trend: Broker-Dealer Participation in EB-5 Financing

by John D. Tishler

Many EB-5 offerings depend on the services of providers who locate and introduce eligible investors. Persons who perform this service are potentially subject to regulation under the broker-dealer laws of the United States and any state in which they conduct these activities. To date, most EB-5 capital has been raised without the assistance of registered broker-dealers. However, the threat of enforcement action by regulators and the risks to project sponsors and regional centers from using unlicensed “marketing agents” and “finders” are setting the stage for increasing involvement of licensed broker-dealers in the EB-5 industry.

This article discusses the reasons for this trend and provides information on various alternatives for conducting EB-5 financing activity within the broker-dealer registration scheme.


The Securities Exchange Act of 1934, as amended (Exchange Act), defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.”  Brokers (and dealers, a separately defined term) are required to register with the Securities and Exchange Commission (SEC) and the states in which they conduct business. Once registered, they are required to become members of the Financial Industry Regulatory Authority (FINRA). As registered broker-dealers and FINRA members, broker-dealers are subject to extensive regulatory requirements and oversight.

Some regional centers and project sponsors raise money for projects they themselves manage.  In that case, they may not fall under the definition of a “broker” because the transactions are not for the account of others. However, individual employees or contractors for these entities may still fall under the definition of broker due to their individual activities to recruit investors on behalf of their employer. Rule 3a4-1 under the Exchange Act provides a non-exclusive “safe-harbor” from registration for associated persons of an issuer of securities engaged in capital-raising activities. Many employees and consultants for EB-5 issuers cannot rely on Rule 3a4-1 because it requires, among other things, that:

  • such persons not be compensated by the payment of commissions or other remuneration based directly or indirectly on a transaction in securities,
  • such persons perform substantial duties for the issuer otherwise than in connection with transactions in securities, and
  • such persons not participate in selling an offering of securities for any issuer more than once every 12 months. 

If Rule 3a4-1 is not available, these persons must determine either that their activities are otherwise excluded from the definition of broker, or that their activities are not subject to U.S. law.

The SEC has indicated that the following factors should be considered in determining whether activities require registration as a broker-dealer: involvement in negotiations, discussing details regarding the transaction or making a recommendation, receiving transaction-based compensation and previous involvement in the sale of securities. In the joint stakeholder phone call with USCIS held on April 3, 2013, a representative from the SEC’s Division of Trading and Markets indicated that transaction-based compensation (what he called a “salesman’s stake”) “in all likelihood . . . would trigger broker-dealer registration.”

In the same phone call, the SEC representatives stated a sweeping view of the applicability of U.S. securities laws, including broker-dealer laws, to raising funds from foreign investors. Under the articulated view, any activity in furtherance of capital-raising conducted from the United States, or using the “means of commerce” (that is, the mail, telephones, etc.) subjects a person to U.S. regulatory jurisdiction even if the majority of the activity is conducted offshore.

The SEC has not always prevailed in court on its more aggressive territorial view or on its narrow focus on transaction-based compensation as a sole trigger for broker-dealer registration.  Engaging in the common practices of EB-5 fundraising nonetheless raises a number of risks, even if the SEC could not ultimately prevail in court.

One large regional center group, CanAm Enterprises, believed that the SEC’s focus and concern warranted the establishment of an affiliated broker-dealer entity. 

Recent SEC enforcement activity

As of the date of this writing, the SEC has not publicly announced any enforcement actions directly related to broker-dealer activity in EB-5 offerings. However, we are aware that certain participants in EB-5 transactions have been issued subpoenas from the SEC Division of Enforcement requesting information about their fundraising activities, including parties to whom such participants paid commissions. 

SEC enforcement activities outside the EB-5 industry indicate an increasing enforcement focus by the SEC on broker-dealer activity.

For example, in March 2013, Ranieri Partners, an unlicensed “finder” hired by Ranieri Partners, and the individual at Ranieri Partners who supervised such finder, settled charges brought by the SEC that they violated the Exchange Act in connection with the finder’s activities. Those activities included transmitting important financial document to the investors such as private placement memoranda, subscription documents, due diligence materials and his personal analysis of the investment.

In late 2012, Neogenix Oncology, a publicly-traded company, filed for bankruptcy and reorganized after the SEC inquired about fees paid to unlicensed finders in connection with private placements conducted by the company. The SEC questioned whether the company should have reserved in its financial statements for liabilities from potential demands by investors for refunds of their investments on the basis of the involvement of unlicensed finders.  Unable to continue to raise funds as result of the uncertainties from the SEC inquiries, the company filed for bankruptcy and reorganized into a new company.

Consequences of the use of unlicensed broker-dealers

The involvement of a person required to be registered as a broker-dealer, but who is not so registered, creates a number of risks to the unregistered party, to the issuer of the securities and its principals, and to the EB-5 investors.

One risk is the possibility of SEC enforcement actions, state regulator enforcement actions and criminal charges brought by U.S. or state prosecutors. Even if the government does not prevail in such actions, the legal costs of defending such actions can be enormous.

A separate concern is the risk that investors may be able to demand return of their investments, known as a rescission right, due to the involvement of unlicensed broker-dealers. It is not clear the extent to which investors have this right under U.S. or state laws, or, if they do have this right, whether they have the right against the unlicensed finder, the issuer of the security or both. However, as illustrated in the Neogenix matter discussed above, the mere threat of rescission rights can create substantial problems for an issuer of securities. For example, if it becomes clear at some point that an EB-5 project will not return money to the investors in the timeframe they expect, those investors, or contingency fee plaintiffs’ attorneys could bring claims against persons deemed responsible for the alleged broker-dealer violation, including parent companies of the project and the individual project executives who promoted the project and supervised the unlicensed individuals. Regardless of merit, these claims may be expensive to defend and the defendant may determine that it is cheaper to settle the action than to pay the costs of defense.

Apart from the costs, government or private-party litigation can cause significant reputational damage and discourage investors from participating in current or future offerings.  

Alternatives for joining the broker-dealer regulatory framework

There are a number of options for involving a licensed broker-dealer, and therefore removing the risk associated with paying commissions and other transaction-based compensation to unlicensed persons.

1.      Register as a broker-dealer:  This alternative requires the creation of an affiliated entity to register with the SEC and each state in which it conducts business, join FINRA, employ individuals with the requisite securities licenses and meet substantial ongoing regulatory, oversight and capital requirements. Each individual who obtains a license must submit detailed information about his/her employment history, criminal background, qualifications, disciplinary issues and any litigation or arbitration actions, as well as study for and take exams. As noted above, this was the alternative chosen by CanAm Enterprises. Smaller regional centers and project sponsors may find this alternative unattractive due to the substantial initial costs and ongoing compliance costs.

2.      Purchase a broker-dealer:  Purchasing an existing broker-dealer may provide the benefits of licensing quicker than registering from scratch.  Also, the buyer may be able to take advantage of the broker-dealer’s existing regulatory infrastructure.  But for many in the EB-5 community, this alternative may be unattractive for the same cost reasons as stated above.

3.      Affiliate with a broker-dealer:  Individuals who obtain appropriate licenses from FINRA as a registered representative may affiliate with a registered broker-dealer firm and receive transaction-based compensation through the registered broker-dealer. Their registrations will be personal to them and therefore not an asset of a regional center or project sponsor that employs such person. Obtaining a registered representative license is, however, significantly easier than registering as a broker-dealer, and this alternative may be attractive to individuals who intend to play a repeated role in EB-5 capital-raising and receive compensation based on the success of fundraising.

4.      Hire a broker-dealer: For many in the EB-5 industry, this will be the most attractive option.  Just as a company that wants to go public will retain a broker-dealer to underwrite the IPO, EB-5 issuers can retain a broker-dealer to assist in raising EB-5 funds.

Until recently, there were few, if any, broker-dealer firms conducting business in the EB-5 space. However, there are now broker-dealer firms offering to provide fundraising services to regional centers and project sponsors looking to raise EB-5 capital. The cost to hire a licensed firm is often less than the commissions that are routinely paid to the unlicensed marketing agents raising money for the majority of EB-5 projects. This is, in part, because the fees that can be charged by a registered broker-dealer are limited by FINRA.

What is involved in hiring a broker-dealer?

A broker-dealer typically performs an initial evaluation of the sponsor and the project before accepting the engagement. During the initial evaluation, the broker-dealer studies the project’s business plan and reviews the experience and qualifications of the management team. The broker-dealer will typically work closely with the corporate/securities attorneys for the project to perform initial due diligence and assess the likelihood of success. By working together, the law firm and the broker-dealer can avoid unnecessary duplication of effort and reduce costs to the project sponsor and regional center. 

A broker-dealer firm will typically charge a non-contingent engagement fee to begin work on a project. Once the broker dealer accepts an engagement to work with a project, the firm will begin preparing for the fundraising process. Broker-dealers are required to maintain and document processes to ensure that the marketing of securities complies with securities laws. The broker-dealer will review the project’s marketing, offering and subscription materials, both in English and the investors’ native language(s), and must conduct due diligence to help ensure the accuracy of these materials. 

Once preparation is complete, the broker-dealer disseminates the project marketing materials and offers documents to their referral resources in the United States and overseas. Once these sources refer potential investors, the broker-dealer evaluates the financial suitability of the investment for the potential investors and also helps to evaluate eligibility for participation in the EB-5 program. As investment capital is raised, the broker-dealer will typically be paid a commission on such capital. The commission will be fully disclosed to investors, will normally include any fees that the broker-dealer pays to its referral sources, and may be paid in whole or in part from the administrative fee normally charged in a syndicated EB-5 offering.

The broker-dealer also has responsibility to ensure the integrity of the investment process, including providing accurate answers to investor questions, ensuring the transfer of funds into escrow and making payments of referral fees in a legally-compliant manner.


We believe registered broker-dealers will become a standard part of the EB-5 landscape.  We also believe that projects that “adopt early” and use the services of licensed broker-dealers will find a competitive advantage in the marketplace, as the required due diligence activities by these firms and the substantial oversight of their activities by U.S. regulators inspire confidence in an investor pool that continues to be shaken by scandals with fraudulent or otherwise poor EB-5 investments.

John Tishler

John Tishler

John Tishler is an EB-5 corporate and securities attorney who practices law as a partner in the Corporate Practice Group in San Diego, California in the Del Mar Heights office of the law firm Sheppard Mullin Richter & Hampton, LLP.

The author would like to thank Elizabeth Thomson and Breanna Cornwall for their assistance in preparing this article.

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