This article is the fourth in a series of articles on how EB-5 regional centers and sponsors can evaluate broker-dealer, investment company and investment adviser registration requirements under U.S. securities laws.
You may want to read: Part 1 – EB-5 offerings do not fit standard SEC registration requirements; Part 2 – Securities broker-dealer registration requirements and hiring U.S. and Non-U.S. brokers; and Part 3 – Investment Company Act requirements.
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Investment Advisers Act or state law registration requirements for investment advisers may apply to managers of EB-5 funds
In a presentation on securities law issues applicable to EB-5 regional centers and sponsors at the May 2014 annual conference of the Association to Invest In the USA (“IIUSA“), the trade association for EB-5 regional centers, a representative of the Securities and Exchange Commission (“SEC“) stated that the registration requirements of the Investment Advisers Act of 1940 (“Advisers Act“) may apply to general partners and managers of EB-5 investment funds. It was recommended that EB-5 regional centers and sponsors consider this issue as part of their efforts to comply with U.S. securities laws. In our view, the Advisers Act should not apply to most EB-5 regional centers or sponsors, for reasons that relate to the characteristics of EB-5 funds in general. However, unless and until the SEC provides further guidance on this issue, it is necessary for every EB-5 regional center and sponsor to analyze the registration requirements of the Advisers Act and determine if they apply. In addition, the regulation of investment advisers is bifurcated between the SEC, for investment advisers with over $100 million in assets under management, and the states, for those with under $100 million in assets under management, and so it is also necessary to determine whether there is a requirement to register as an investment adviser under applicable state law.
Why would the Advisers Act apply to EB-5 regional centers or sponsors if they don’t render investment advice to investors in their funds?
Many EB-5 regional centers and sponsors of EB-5 investment funds specifically disclaim in their offering documents that they are giving investment advice to any investors in their funds. However, the Advisers Act and some state securities laws consider the manager or general partner of an investment fund as the investment adviser of that fund, if the fund invests in securities (loans and equity investments in project companies are considered securities). So, even though EB-5 regional centers and sponsors are not providing investment advice to investors, they may be considered to be providing advice to the EB-5 fund itself. Therefore, unless an exemption from registration is available, the manager or general partner of an EB-5 investment fund that invests in securities may be required to register as an investment adviser under the Advisers Act or applicable state law. For the reasons explained below, we believe that the Advisers Act registration requirement should not apply to EB-5 investment funds, but that it is possible that the manager or general partner of some EB-5 investment funds might be required to register under applicable state law. Even if a manager or general partner of an EB-5 investment fund determines that it may be subject to registration, another option is to retain an independent registered investment adviser to provide any necessary advice concerning securities to the EB-5 investment fund, rather than having the manager or general partner become registered as investment adviser, as is also explained further below.
Until 2012, the Advisers Act had an exemption for any investment adviser with fewer than 15 clients, and a fund was treated as a single client, which meant that many investment fund managers were exempt because they managed fewer than 15 funds. Many states had similar exemptions based on the number of clients in the state, and many states still have these exemptions, but the number of investors permitted under each state’s laws vary.
The Advisers Act was amended as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act adopted in 2010. As a result, since 2012, managers of “private funds” with “assets under management” (or “AUM“) in excess of $150 million are now required to register with the SEC under the Advisers Act, and those with AUM between $100 million and $150 million are required to file but not be registered with the SEC as “exempt reporting advisers.” Those with AUM under $100 million are directed to register under applicable state laws if required under those laws. Each manager or general partner of an EB-5 fund needs to determine first whether it is a manager of “private funds”, and if so, what is the amount of its AUM.
What is a “private fund” under the Advisers Act?
A “private fund” is defined under the Advisers Act as a private investment fund that would be required to be registered under the Investment Company Act of 1940 but for the exemptions provided under Sections 3(c)(1) or 3(c)(7) of that Act. (See Part 3 of this series for more information about those exemptions.) According to this definition, an EB-5 investment fund that is exempt under Section 3(c)(5) of the Investment Company Act, because it invests only in real property or in loans secured by real estate, would not be defined as a “private fund” under the Advisers Act. However, an EB-5 investment fund that invests in equity securities of a project company (other than a wholly-owned subsidiary of the EB-5 fund), or makes a loan to a project company that is not secured by real estate, since it will be relying on the exemptions under Sections 3(c)(1) or 3(c)(7), will be considered a “private fund” under the Advisers Act.
What happens if an EB-5 regional center or sponsor manages several EB-5 funds, and some of them are exempt under 3(c)(1) of the Investment Company Act, but others are exempt under 3(c)(5) of the Investment Company Act?
This is not an uncommon situation for many EB-5 regional centers or sponsors, but the answer to this question gets tricky because of an exemption from registration under the Advisers Act adopted by the SEC in 2011 for advisers of “private funds” with less than $150 million in AUM, under SEC Rule 203(m)-1. The exemption is for persons who are managers “solely” of “private funds” with AUM under $150 million. An adviser that has one or more clients that are not “private funds” is not eligible for the exemption. In order to provide the benefit of the exemption to advisers who manage funds exempt under 3(c)(5) as well as funds exempt under 3(c)(1) and 3(c)(7), the Rule states that an adviser can treat funds exempt under 3(c)(5) the same as funds exempt under 3(c)(1) and 3(c)(7), and still be exempt. If a manager or general partner does manage both types of funds, it would include potentially all of the AUM of all EB-5 investment funds managed by that manager or general partner.
Is each EB-5 fund considered separately, or are all EB-5 funds aggregated to determine the total AUM under management?
All EB-5 funds that are managed by a manager or general partner would be aggregated for purposes of determining the total AUM managed by that manager or general partner. For this purpose, even if separate legal entities are formed to act as the manager or general partner of each EB-5 fund, the SEC will generally treat all entities that are under common ownership and control as a single entity. This means that, in order to determine the amount of AUM, the assets of all EB-5 funds that are managed by entities under common ownership and control must be aggregated.
What are “assets under management” or “AUM” under the Advisers Act?
The Advisers Act defines “assets under management” (or “AUM”) as the “securities portfolios” with respect to which an adviser provides “continuous and regular supervisory or management services,” which means there are two parts to this definition. The first part is whether an EB-5 investment fund holds “securities portfolios.” According to the SEC’s definitions under the Advisers Act, a manager of a “private fund” is required to treat all of the assets of the fund as part of its “securities portfolio,” even if some of the assets are real estate. (The rule is different for managers of individual accounts, where assets are counted only if the account portfolio is over 50% invested in securities, but that is not relevant for the purpose of EB-5 investment funds.) So, for this purpose, if an EB-5 fund is classified as a “private fund”, then 100% of its assets are considered part of its “securities portfolio”, even if the assets are not technically “securities.”
The second part of the definition – whether assets are under “continuous and regular supervisory or management services” – is the key to whether EB-5 investment funds will have AUM sufficient to require registration under the Advisers Act. According to the SEC’s specific instructions for calculating AUM, the SEC states that making an initial asset allocation, without continuous and regular monitoring and reallocation; or providing advice on an intermittent or periodic basis (such as in response to a market event, or on a specific date) is not considered “continuous and regular supervisory or management services.”
Do the managers of EB-5 funds provide “continuous and regular monitoring” of assets?
Because of the requirements of the EB-5 program, virtually every EB-5 investment fund makes one initial investment, which is fully disclosed to all investors, and that is the sole investment ever made by the fund. The only time that an EB-5 investment fund might potentially make another investment would be in the event of an early repayment by a project company to the EB-5 investment fund, if the fund manager determined that it might protect the EB-5 investors’ eligibility for I-829 petition approvals if the proceeds were redeployed to another investment. That would generally be a rare event, and according to the SEC’s instructions, would not qualify as “continuous and regular supervisory or management services.” Therefore, under the SEC’s definition of AUM, virtually all EB-5 fund managers would be exempt from SEC registration under the Advisers Act, because they do not provide “continuous and regular supervisory or management services” over the assets in the EB-5 funds that they manage. We therefore believe that it would be rare for any manager or general partner of an EB-5 investment fund to have sufficient AUM to qualify for SEC registration under the Advisers Act.
Are state investment adviser registration requirements applicable to managers of EB-5 investment funds?
The answer may be yes in some states, and no in other states. Each state has different rules for registration of investment advisers, and they are not all modeled on the federal Advisers Act. It is first necessary to determine what state’s laws apply to a manager, and that is typically the state where the principal place of business of the manager is located, and may also include one or more other states if the principal place of business of the EB-5 investment funds are located in states other than the state where the manager or general partner has its office. When the relevant states are determined, it is then necessary to review the laws of those states to determine if there are possible exemptions based on the number of funds being managed. In some states, such as California, a manager of even one investment fund may be required to register, but there is an exemption for managers of private funds that is similar, but not identical to the federal exemption for private fund advisers. In other states, no registration is required unless the manager has over a certain number of clients, with each fund counting as a single client for this purpose.
In addition to the possible stated exemptions from registration under state law, there is also an overriding question of whether the manager or general partner is in fact providing investment advice to its EB-5 funds, since these funds typically make one investment for the life of the fund, with a possible reinvestment only if necessary to preserve the eligibility of the EB-5 investors for their I-829 petition approvals. It may be possible to obtain advice from the relevant state securities agency that under these circumstances registration is not required.
The other option that may be considered by managers or general partners of EB-5 investment funds is to retain a registered investment adviser to provide investment advice to the funds. Since there is only one initial investment decision, and a possibility of a reinvestment decision that could be triggered by an early disposition of a fund’s investment, it does not appear that the role of the registered investment adviser would extend beyond the initial investment and any subsequent reinvestment.
What Should EB-5 Regional Centers and Sponsors Do?
Every EB-5 fund manager or general partner should analyze whether they would be required to register as an investment adviser under the laws of the state where their principal place of business is located, or whether they qualify for an exemption from registration. In addition, they should determine what conditions may apply to be eligible for the exemption. As indicated above, we do not believe that the Advisers Act should apply to most if not all managers or general partners of EB-5 funds, because they do not exercise “continuous and regular supervisory or management services” over the assets of EB-5 funds. Based on the SEC’s instructions for making this determination, it does not appear that managers or general partners who managed only EB-5 funds would even be eligible to register, because their role in the investment decisions of these funds is so limited that they would not have the required amount of AUM. We would encourage the sponsors of EB-5 funds to seek an acknowledgement of this conclusion from the SEC.