By Osvaldo Torres
The EB-5 program is under attack, and came precipitously close to being revamped in a manner that would have created unreasonable compliance obligations on regional centers. There is concern about certain abuses and wrongdoing by some bad actors that, rightfully, have become very public. Not surprisingly, instilling “integrity” into the EB-5 program is the battle cry from Capitol Hill.
Many of the presently-proposed goals of EB-5 program reform are laudable and appropriate. Others are based upon a cry for change that may lead to more, possibly unnecessary regulation that could have a chilling effect on the industry and create regulatory ambiguity.
Every single act of wrongdoing by bad actors in the EB-5 industry discovered and prosecuted to date reveal that sufficient and effective laws, rules and regulations are already in place to punish wrongdoers (See Section 17(a) of the Securities Act of 1933, which prohibits fraud or misrepresentations in the offer of sale of securities). For example, if a project principal diverts EB-5 funds for personal use or to an unauthorized project, such as in SEC v. A Chicago Convention Center, et al, SEC. v. Lee, et. al and SEC v. Ramirez, et al, plenty of laws and common law remedies exist to punish such fraud (See Rule 10b-5 of the Securities Exchange Act of 1934, which makes it unlawful to directly or indirectly employ any device, scheme or artifice to defraud; make false statements or omit material information or; otherwise conduct operations that would deceive or defraud any person in connection with the purchase or sale of a security). If an offering document contains material misstatements or omissions, the existing SEC laws regulate such activities and provide sufficient remedies for such abuses (See Section 17(a) of the Securities Act of 1933).
In the end, the integrity concerns that have assaulted the industry may be based on a lack of clarity regarding the nature and role of regional centers. That is where the compliance conundrum begins.
At its simplest, a regional center is an economic unit authorized by USCIS to conduct economic activity that will promote economic growth within the geographic area designated by USCIS. The main benefit of locating a project within a regional center is the ability to count indirect as well as direct jobs to meet the minimum job creation requirement.
When the regional center itself, or an affiliate, owns and controls the job creating entity, the new compliance issues proposed in the “American Job Creation and Investment Promotion Reform Act of 2015” introduced by U.S. senators Leahy and Grassley (the “Leahy/Grassley Bill”) would seem less problematic. But what if the regional center sponsors, contracts with or rents its regional center status to an unaffiliated new commercial enterprise (NCE)? What degree of oversight and control should the regional center exercise over the activities of the unaffiliated NCE? What liability should the “rent-a-center” incur for the misdeeds of the NCE to which it rents its status? Many are divided on the answers to these questions.
Certainly the lack of appreciation by some EB-5 professionals regarding the applicability of securities laws to the EB-5 program, greed on the part of various EB-5 participants (including project sponsors, regional centers, migration agents and immigration attorneys), and failure by the SEC to more actively regulate the EB-5 industry until the Chicago case forced the SEC to become aggressive in its enforcement outlook bred noncompliance under the EB-5 program. However, the new integrity bill may take matters too far by trying to impose “issuer liability” on a regional center even when it does not control or affiliate with the NCE. In the typical EB-5 loan model deal, the NCE is the entity that pools the EB-5 investment funds and is the issuer or seller of the securities to the EB-5 investors. Once the EB-5 funds are available for investment, the NCE makes a loan to the job creating entity. As the issuer of the securities, the NCE and its controlling persons would generally bear any liability for any material omission or misstatement in connection with an offering. The fundamental test for materiality is whether there is a substantial likelihood that a reasonable investor would consider the misstatement or omission important in deciding whether or not to purchase or sell a security (Basic Inc. v. Levinson, 485 U.S. 224). As the U.S. Supreme Court stated in Basic, “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
If the regional center or its controlled affiliate is the issuer, then in such case the regional center should bear the liability for the harm. If, on the other hand, the regional center is not the issuer, is not affiliated with the issuer or does not otherwise control the issuer, the Leahy/Grassley bill would have imposed or imputed such “issuer liability” to the “rent-a-center.” How? Because the regional center would have been required to issue a certificate affirming that the offering complied with applicable securities laws. Specifically, both the Leahy/Grassley bill and the recently introduced “EB-5 Integrity Act of 2015” provide that a regional center must annually reissue a certification affirming, among other things, that—
“(bb) to the best of the certifier’s knowledge, after a due diligence investigation, all [. . .] offers, purchases, and sales of securities or the provision of investment advice complied with the securities laws of the United States and the securities laws of any State in which the offer, purchase, or sale of securities was conducted, or the issuer of securities was located, or the investment advice was provided [.]” (EB-5 Integrity Act of 2015, S. 2415, 114th Cong. 32-33 (2015).
But what would it take for a certifier to become sufficiently capable of and comfortable with providing such certification? Giving a certificate that essentially “blesses” an offering is not a matter to be taken lightly. Would prudence not dictate that the certifier seek and rely on a legal opinion? But what lawyer would give a legal opinion on such a matter without insisting on customary carve-outs and other qualifications—such as to matters that the lawyer has not and may never be able to verify without conducting exhaustive, expensive and time-consuming due diligence? Would any such investigation lead to the discovery of any material omissions, misstatements or outright fraud?
The problem is that the determination of materiality is a mixed question of law and fact, and the SEC has made clear that there is no bright-line quantitative test for materiality. Placing the burden of making such discovery on a regional center that has no affiliation with or control over the NCE appears misplaced and unfair, and should not be the law. Let the issuer bear that responsibility alone, absent collusion or other facts that would make the regional center complicit.