Is an investment a “security” under the federal securities laws if it is made in part for reasons unrelated to investment returns? And can someone who facilitates the investment be liable for securities fraud? In SEC v. Feng1, the Ninth Circuit answered both questions affirmatively – helping to clarify what qualifies as a “security” under – and so who may be covered by – the federal securities laws.
Hui Feng was a practicing attorney specializing in obtaining EB-5 visas on behalf of his clients. The EB-5 program, also known as the U.S. Immigrant Investor Program, allows foreign nationals who make investments of between $500,000 and $1,000,000 in the United States to obtain legal permanent residency under certain circumstances.2 As part of this program, multiple foreign investors may pool their money in the same enterprise through use of so-called “regional centers.” Each regional center offers specific economic enterprises to investors and manages the pooled investments. Feng’s legal practice assisted roughly 150 foreign clients through the EB-5 program. His services included acting as a liaison between clients and the regional centers, explaining the English-language offering materials to his clients, negotiating with the regional centers regarding administrative fees charged to his clients, and compiling and submitting his clients’ signed offering documents to the regional centers.
Without informing his clients, Feng also entered into marketing agreements with the regional centers under which Feng promoted the regional centers to his clients in exchange for a commission. Because the regional centers refused to pay a commission to a U.S.-based attorney who was not a registered broker-dealer (as required by the federal securities laws), Feng established relationships between regional centers and foreign “referral partners.” In reality, these “referral partners” were Feng’s wife, mother, and mother-in-law, who did not do any work to find or identify investors and forwarded commission payments from the regional centers back to Feng. Feng also created a company that entered into marketing agreements with regional centers without disclosing to the regional centers (or to his clients) that he was the company’s beneficial owner and had sole control over its bank account.
The Securities and Exchange Commission charged Feng with failing to register as a broker-dealer under Section 15(a) of the Securities Exchange Act of 1934,3 and fraud under Section 17(a) of the Securities Act of 1933,4 Section 10(b) of the Securities Act of 1934 and SEC Rule 10b-5.5 Among other defenses, Feng argued that EB-5 program investments were not “securities” because investors made them to obtain a green card, and not to secure a profit. In support, Feng relied on the administrative fees paid in connection with the investments and argued that these fees cancelled out any return on the investments.
The Court rejected Feng’s arguments, adhering to its long-standing precedents that define “security” quite broadly for purposes of the federal securities laws. First, the Court examined features of the EB-5 program transactions and noted that they were structured as limited partnerships with the promise of a fixed annual return – traits associated with securities. Second, the Court examined the agreements between the regional centers and Feng’s investors and found that they referred to the investments as “securities” and asserted that the investments complied with U.S. federal securities laws. The agreements also distinguished between the investments and the administrative fees, undermining Feng’s argument that the administrative fees negated any expected investment return. Third, the Court noted that the investments had to create at least ten jobs to allow the investor to qualify for a green card. Accordingly, Feng’s clients had an interest in the success of their investments. Concluding that the EB-5 program investments were securities, that Feng had failed to register as a broker-dealer and that he made material misstatements and omissions to his clients/investors, the Court affirmed the lower court the judgment holding that Feng had violated the federal securities laws.
Feng holds that an investment that has attributes of a security will likely fall within the traditionally broad definition of “security” under the federal securities laws even if the investment advances other, non-investment-related purposes. As such, these investments, and those who promote them, can be subject to the federal securities laws and the investor protections that federal law provides.