Many regional centers form limited partnerships or other pooled investment vehicles known as new commercial enterprises in EB-5 terminology to raise capital for project companies seeking to use the regional center’s designation granted by the USCIS. These regional centers may be motivated by keeping the identity of their migration agents confidential or simply by the desire to generate a greater economic return for its principals by paying investors a preferred return of 2% while charging the project companies 5% interest, thereby making the spread. Whatever the reason, the repeated formation of pooled investment vehicles to provide financing to project companies may constitute capital raising (i.e., effecting transactions in securities) for the account of others which requires registration as a broker-dealer under Section 15(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
According to the SEC, the SEC’s Division of Trading and Markets is actively investigating regional centers engaged in the above-described activity for referral to the SEC’s Division of Enforcement. Further, the SEC now has specific staff members devoted to matters relating to the EB-5 Program and, at least one such staff member, has stated that the EB-5 Program is on its radar. According to this staff member, the SEC is actively seeking tips regarding, and is currently investigating, regional centers for unlawful broker-dealer activity and expect enforcement actions to be forthcoming.
As discussed below, the use of pooled investment vehicles to raise capital to loan to project companies may require the regional center and its representatives to register with the SEC as a broker-dealers or “associated persons” of a broker-dealer.
Broker-Dealer Registration Requirement
Section 15(a) of the Exchange Act makes it unlawful for any entity (or a natural person who is not associated with a broker or dealer) to make use of any means of interstate commerce to effect any transaction in any security unless registered under the Exchange Act. Section 3(a)(4) of the Exchange Act generally defines the term “broker” to mean any person engaged in the business of effecting transactions in securities for the account of others. The term “broker” is broadly interpreted by the SEC staff. Being a broker is not necessarily dependent upon the receipt of a commission or other compensation directly related to sales of securities. Persons engaged in the business of soliciting prospective investors in an Issuer fall within the definition of “broker” and, absent an available exemption, are required to register as, or be associated with, a broker dealer under the Exchange Act.
Historically, it has been recognized that issuers of securities (i.e., a pooled investment vehicle organized by a regional center) engaged in the offering of their own securities are not brokers. However, this exemption does not apply to any employee or other person related to the issuer (i.e., the individuals associated with the regional center or the regional center’s affiliates) who routinely engages in the business of effecting securities transactions for the issuer or a related party (i.e., the regional center or other pooled investment vehicles sponsored by the regional center). Such employees and other related persons of an issuer who assist in selling its securities may be “brokers,” especially if they are paid for selling these securities and have few other duties, and particularly if they are paid amounts tied to the value of what they cause to be sold by the issuer. Accordingly, to avoid the need for registration as a broker-dealer under the Exchange Act, such employees and other related persons generally rely on a “safe harbor” provided under Rule 3a4-1 of the Exchange Act discussed below.
Rule 3a4-1 Issuer Exemption
Rule 3a4-1 under the Exchange Act provides a non-exclusive “safe harbor” for persons associated with an issuer to avoid broker dealer registration (or licensing as an associated person of a broker-dealer). Such associated persons include any natural person (not entity) who is a partner, officer, director, or employee of: the issuer; a corporate general partner of a limited partnership that is the issuer; a company or partnership that controls, is controlled by, or is under common control with, the issuer; or an investment adviser registered under the Investment Advisers Act of 1940 to an investment company registered under the Investment Company Act of 1940 Act (“ICA”) that is the issuer.
Under the rule, an associated person will not be deemed to be a broker solely because of that person’s participation in the sale of securities so long as the associated person meets certain conditions. Some of the key provisions of Rule 3a4-1 are as follows:
- The associated person may not be compensated, directly or indirectly, in connection with the offering of the issuer’s securities (i.e., transaction-based compensation); and
- The associated person primarily performs substantial duties for or on behalf of the issuer otherwise than in connection with transactions in securities; was not a broker or dealer, or an associated person of a broker or dealer, within the preceding 12 months; and does not participate in selling an offering of securities for any issuer more than once every 12 months; or
- The associated person restricts his or her participation to one or more of the following activities: preparing or delivering written communications that do not involve oral solicitation by the associated person of a potential purchaser; responding to inquiries of potential purchasers in a communication initiated by the potential purchaser; and performing ministerial and clerical work involved in effecting any transaction.
Application to Regional Centers
Typically, regional centers undertake (or attempt to undertake) more than one financing transaction each year. As such, the 3a4-1 “safe harbor” discussed above does not provide an available exemption from registration to those regional center principals and employees who participate in discussions with migration agents or undertake other capital raising activities for such pooled investment vehicles or their project company borrowers more than once every 12 months. Accordingly, to comply with the law, such regional centers and/or their principals and applicable employees should register as broker dealers and/or licensed “associated persons” of a broker dealer with the SEC.