by Osvaldo Torres
Those looking to raise capital through the EB-5 Immigrant Investor Program must comply with both state and federal securities regulations in addition to the USCIS EB-5 regulations. This requires the issuers of the securities (i.e., the partnerships, limited liability companies, etc.) to either: 1) register their offers with the appropriate governmental authority, or 2) satisfy an exemption. In order to comply with the Securities Act of 1933, as amended (“Securities Act”), most opt to satisfy the exemption requirements of Rule 506 of Regulation D and/or Regulation S. Each of these exemption mechanisms places different restrictions on advertising, so it is important to consider the regulations before marketing a project to potential investors.
Rule 506 of Regulation D
Rule 506 does not itself provide the exemption, but it provides the conditions that an issuer must satisfy to meet the requirements of the underlying exemption of Section 4(a)(2) of the Securities Act. Section 4(a)(2) is an exemption for “transactions by an issuer not involving any public offering.” Under Rule 506(b), the securities may be purchased by an unlimited number of accredited investors, but only up to 35 non-accredited, yet sophisticated, investors. In addition, the use of general solicitation to market the securities is prohibited. “General solicitation” includes advertisements through newspapers and magazines, social media, public websites, television, radio and seminars where attendees have been invited by general advertising. A benefit to relying on the Rule 506 exemption is that the rule preempts state securities laws, so issuers that offer securities under the Rule 506 exemption are also exempted from registration under state securities laws (except for notice filings and filing fees).
Even though registration is not required, all issuers must still file a Form D within 15 days after the first sale of securities. Form D is a notice to the Securities and Exchange Commission (“SEC”) that includes the names and addresses of the company’s owners and stock promoters, but contains little other information about the company.
If issuers want to rely on the safe harbor of Rule 506(b), they are not able to offer their securities to the public through any means of general solicitation, including magazines, unrestricted websites or mass emails. The SEC warns that while the solicitation must be an “offer” of securities, solicitations that condition the market for an offering of securities may be considered offers. Therefore, all parties involved in an EB-5 project are cautioned not to publicize details about current offerings relying on Rule 506(b). However, issuers and regional centers may list their prior, closed EB-5 projects in any means of general solicitation.
Regulation S provides an exemption from registration for those offers and sales of securities that occur outside of the United States. This exemption is less restrictive about general solicitation, but it does not preempt state law or foreign laws, so issuers are still required to comply with the applicable state laws that may prohibit general solicitation. Notice filing with the SEC is not required for this exemption. In order to qualify for exemption, the following conditions must be met: 1) the offer or sale must be made in an “offshore transaction”; 2) there must not be any “directed selling efforts” in the United States (i.e., websites or magazines that are viewable in the United States cannot be used), and 3) depending on the category under Rule 903(b) of Regulation S that the securities fall under, the offer and sale must meet certain other conditions for that category.
Changes to Rule 506 relating to general solicitation
With the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), Congress required the SEC to amend Rule 506 of Regulation D to permit issuers of securities in private placements to raise capital through general solicitation and advertising. To implement the JOBS Act requirements, the SEC adopted paragraph (c) of Rule 506. Rule 506(c) provides that issuers can offer securities through means of general solicitation if: 1) all purchasers in the offering are accredited investors; and 2) the issuer takes reasonable steps to verify the purchasers’ accredited investor status. Offerings utilizing Rule 506(c) will still be able to raise an unlimited amount of capital, but unlike Rule 506(b), Rule 506(c) does not allow any non-accredited investors to purchase securities in a Rule 506(c) offering, and it does allow public advertising. This new rule became effective on September 23, 2013.
In order to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has also adopted provisions 506(d) and 506(e), which disqualify “bad actors” from relying on Rule 506 (b) or (c). Under Rule 506(d), an offering may not rely on Rule 506 if the issuer or any other person covered by the rule has a relevant criminal conviction, regulatory or court order or other disqualifying event (as listed in the rule) on or after September 23, 2013. For disqualifying events that occurred before that date, issuers may still rely on Rule 506 if they comply with the disclosure provisions provided in Rule 506(e).
The SEC believes that the Rule 506(c) exemption will allow issuers to reach more potential investors and therefore increase their access to capital, which, at the end of the day, should increase the number of U.S. jobs (a crucial piece of the EB-5 requirements, and at the core of the spirit of the program). However, concern over this new general solicitation freedom has caused the SEC to consider additional rules regarding investor protections.
Specifically regarding Form D, the SEC is proposing to tighten filing deadlines, expand the amount of information on accredited investors that is required by the form, and establish stricter disqualifications for noncompliance.
Other SEC proposals include: 1) Rule 510T, which would be a temporary rule requiring issuers of Rule 506(c) offerings to submit to the SEC all marketing materials to be used in general solicitation; 2) Rule 509, which would require issuers to include prescribed legends in any written communication that constitutes general solicitation in any offering relying on Rule 506(c); and 3) revising the definition of accredited investor.
Frequently asked questions
1) What is an “accredited investor”?
Under Rule 501 of Regulation D, an accredited investor includes a natural person who: a) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same level of income for the current year; or b) has a net worth of over $1 million (either individually or with a spouse), excluding the value of the person’s primary residence.
2) What are “reasonable steps” to verify whether an investor is accredited?
The issuer will make the objective decision, based on the particular facts and circumstances of the transaction whether or not the verification steps are reasonable. The SEC pro- vides factors that an issuer should consider including:
- The nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- The amount and type of information that the issuer has about the purchaser;
- The nature of the offering (how the purchasers were solicited); and
- The terms of the offering, such as a minimum investment amount.
3) What types of verification methods may issuers use?
Rule 506(c) provides a non-exclusive list of verification methods, including:
- Verification based on income, through review of any IRS forms that report income for the two most recent years, and written representation from such investor that he or she has a reasonable expectation of reaching the same level of income for the current year;
- Verification of net worth, through review of one or more of the following types of documents dated within the last three months: bank statements, brokerage statements, certificates of deposit, tax assessments and credit reports; and review of written representation from such investor that all liabilities necessary to make a determination of net worth have been disclosed;
- Possession of a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person has taken reasonable steps to verify that the purchaser is an accredited investor within the last three months and has determined that such purchaser is an accredited investor; and
- Possession of a certification from the investor at the time of sale that he or she qualifies as an accredited investor, for any person who invested in an issuer’s Rule 506(b) offering as an accredited investor prior to September
4) What else must an issuer do to rely on Rule 506(c)?
Currently, issuers must file Form D with the box checked that indicates reliance on Rule 506(c) within 15 days of the first sale of securities in the offering. In addition, issuers must always adhere to the anti-fraud provisions of the federal securities laws including the Securities Act, the Securities Exchange Act of 1934, as amended, and the Investment Advisers Act of 1940 (if applicable).
5) Does the new rule affect Rule 506(b) offerings?
No. Rule 506(b) remains unchanged and available to issuers conducting a Rule 506 offering without general solicitation or with non-accredited investors.
6) Can I rely on Regulation D and Regulation S simultaneously?
Issuers of securities for an EB-5 investment often simultaneously rely on both the Regulation D and Regulation S exemptions in case one exemption does not cover all of the investors, one exemption fails and a backup is needed, or not all of the required funding is able to be raised through EB-5 investment.
7) Can I use publicly available websites to attract interest in investment opportunities without additional verification?
A website may provide general information that is not related to a specific offering on publicly available web pages. However, if relying on Rule 506(b), prior to receiving any information about a specific issuer or investment, the user must go through a verification process to determine if the investor is accredited. Web pages that have information specific to an investment must be password-protected or they would be considered general solicitation.
8) Can I advertise past or future projects online or in a newspaper or magazine?
Past projects can be advertised through any means of general solicitation. Securities laws prohibit advertising of offerings if relying on an exemption that requires no public offering be made, such as Rule 506(b). When merely describing a past project, there is no offering of securities being made, however, it is always good practice to notify the public that past results are not indicative of future results. Future investment opportunities should not be advertised.