At the end of August, the Financial Industry Regulatory Authority, Inc. (FINRA) issued aninterpretive guidance letter to a registered broker dealer (BD), Trustmont Financial Group, Inc. (Trustmont). Trustmont had sought guidance on the applicability of FINRA Rules, and in particular Rule 2111 (Suitability), to FINRA members’ recommendations of securities transactions in connection with the EB-5 Immigrant Investor Program. FINRA is an independent regulator of securities firms doing business with the public in the United States. The Sheppard Mullin corporate and securities group will be publishing a detailed discussion regarding the implications of this guidance for the EB-5 community; I wanted to share some initial thoughts, from an immigration attorney’s perspective.
I see two important messages. First, due diligence for an EB-5 transaction includes an investigation into traditional investment due diligence — issues that address the legitimacy and viability of the issuer’s enterprise. Second, due diligence for an EB-5 transaction also includes determining whether the private placement is consistent with the regulations and requirements associated with the EB-5 program. Broker-dealers are required to do both, and wherever broker-dealers are not involved, investors are well advised to make sure that other competent parties are involved and addressing these issues.
In April of 2013, during the USCIS EB-5 stakeholder meeting with the Securities & Exchange Commission (SEC), the SEC confirmed the application of various securities laws to EB-5 offerings. While this came as a surprise to some, seasoned securities and immigration attorneys had already been advising regional centers, project developers, and consultants about the securities-related responsibilities in any EB-5 deal as well as the need for disclosures from an immigration perspective in the offering package. We endured pushback, and in some cases, disdain for this advice. Many in the industry continued to use offering materials that were unfit for securities offerings and to ignore the regulatory schemes applicable to offerings of securities.
Why? Perhaps because the U.S. Citizenship and Immigration Services was routinely approving Regional Center (or “RC) applications and a good number of projects associated with these RCs without considering the securities laws and the appropriateness of the disclosure. With deals approved, conditional residency granted and no expectation by investors of seeing their money back for five or more years (so no complaints, as these generally arise when investors fear they have lost money), why worry?
However, several EB-5 regional centers and project developers saw the writing on the wall. They began to improve processes and took regulatory obligations more seriously. The need for EB-5 related compliance (on all parties including investors), increased oversight (by the government and self-monitoring processes), and the adoption of industry best practices and standards is finally becoming mainstream thinking.
This turning of the tide now includes foreign agents who are demanding more financial information (such as projections), improved disclosures, and accurately translated documents that investors can actually read. Today, it seems that these emigration agents are looking to promote safer, higher quality projects.
What Does This Mean to BDs in Terms of Due Diligence?
The FINRA Guidance Letter states:
“A broker-dealer also should analyze whether the private placement is consistent with the requirements of the EB-5 Program, such as whether it constitutes an investment in a domestic project that will create or preserve at least 10 jobs for U.S. workers.”
I note that immigration due diligence under the above standard is not limited to the job creation aspect of the investment, and of course, the letter notes that BDs must also perform traditional investment due diligence.
While far from an exhaustive list, the following is a list of actions we typically consider when performing immigration due diligence for our investor clients:
- Review backgrounds on the principals of the RC and/or project
- Study the qualifications and reputation of the economist producing the economic RC study (quantity of reports issued is not sufficient)
- Have a qualified individual breakdown the fees, the specifics of the return of investment, and the “waterfall” (the priority of payments ahead of the EB-5 investors)
- Evaluate the percentage of EB-5 money in the capital stack and where the other money is coming from (i.e., Does the developer have skin in the game?)
- Consider the job cushion (i.e., How many jobs over the requisite ten are being projected?)
- Evaluate reasonableness of the data inputs, including whether or not 3rd party feasibility studies were conducted (consider engaging an industry expert to review data)
- Demand disclosure of agent compensation (i.e. who is getting paid, how much, when and on what conditions)
- Determine investor’s place in line for job allocation
- Review reasonableness of the project timeline (paying attention to when jobs are being created as well as the current delay in USCIS processing times – now over 18 months for I-526 adjudications)
- Review and assess escrow terms and the possibility of return of funds if I-526 is denied based on no fault of the investor. (Note: an increasing number of projects are requesting funds be released directly into the project which may be fair and acceptable especially in cases of an exemplar approval issued by USCIS.)
Other items that all EB-5 related parties should be watching closely include the impact of any immigration reform legislation, Senator Grassley’s EB-5 fraud investigation, and the Inspector General’s EB-5 review. Any one of these could affect a particular project or the EB-5 program as a whole. Similarly, it should be noted that studying projects from an immigration perspective generally requires economic and industry-specific expertise.