SEC Charges Unregistered Broker for Illegally Brokering Sales of EB-5 Securities
On March 5, 2018, the Securities and Exchange Commission ("SEC") charged a New York-based company with illegally brokering dozens of private placement investments by foreign nationals seeking U.S. residency through the EB-5 Immigrant Investor Program (In the Matter of Edwin Shaw, LLC, Administrative Proceeding File No. 3-18384). This news should create pause for any firm or individual who is involved in EB-5, who raises capital, advises foreign nationals on investments, or holds themselves out to the general public as being able to provide "EB-5 financing", even indirectly. Such firms or individuals should take a serious look at their business activities and seek legal counsel to determine if they should be engaging with a registered broker-dealer, become individually licensed with a broker-dealer, or if they themselves should become licensed as a registered broker-dealer. Over the past few years, the issue of whether to have a FINRA registered broker-dealer market an EB-5 private placement has been a debated topic amongst industry players, albeit met with confusion and conflicting conclusions in most cases, specifically within the industry's close-knit group of "go to" securities attorneys in EB-5. While some regional centers and issuers took a conservative approach and engaged a registered broker-dealer to avoid any potential risk of violating securities laws, there are still many who refuse to abide by these rules under false pretenses. They are led to believe that they are exempt because an EB-5 private placement does not fall under the same legal and regulatory rules as non-EB-5 private placements, or if they are working with foreign migration agents to assist in the capital raising, this also excludes them from adhering to U.S. securities laws. This logic is completely flawed, as they themselves are U.S. persons, based in the U.S. and raising capital and effectuating securities transactions on behalf of others. It appears there is a common theme in general amongst these parties that are mostly comprised of regional centers, marketing firms, and consultants involved in EB-5 before the published regulatory guidelines by the SEC and FINRA in 2016 (http://www.finra.org/industry/2016-regulatory-and-examination-priorities-letter). Furthermore, these individuals are not motivated to work with a broker-dealer or to become licensed, because it would mean less money to be made from the investor's administrative fee, and/or the annual interest charged. Some have tried to be creative, taking the approach of setting up offshore divisions that are the exclusive "marketing" arms of their regional center, with all administrative fees and payments to brokers handled through the offshore entity.
Even more startling, a handful of these "go to" securities attorneys advise their clients that they do not need a FINRA registered broker-dealer, and can rely on certain exemptions available to issuers, i.e. the "Issuer Exemption", which has its restrictions, and is often misused. The "Issuer Exemption", in addition to limiting a securities offering by a party to once every 12-months, also applies to individual employees or agents of the issuer, and indicates that individuals acting on behalf of the issuer engaged in distributing its securities, including the issuer's own directors, officers or employees, may be deemed 'brokers' under Section 3(a) of the Securities Exchange Act of 1934. This includes members of any general partnership or manager entity that is formed to manage the issuer. Although there are attorneys who will always advise that any EB-5 private placement offering should have a registered broker-dealer involved, and at a minimum providing the compliance oversight, there are many attorneys who advise their clients that the involvement of a registered broker-dealer is not necessary simply because the private placement is using EB-5, the party is a regional center or the party is only marketing to foreign nationals or foreign migration agents. But the bottom line is that there isn't any rule both at the federal or state level that confirms that a regional center is exempt from U.S. securities laws related to registering as a broker-dealer.
Perhaps this recent SEC decision will make it clear to all attorneys as to the legal requirement of having a registered broker-dealer as part of an EB-5 project where the parties cannot clearly rely on the Issuer Exemption.
In the SEC matter here, the Respondent was a New York limited liability company, who was marketing, soliciting and facilitating the sale of the LLC Membership Interests (securities) of the issuer, which was a New York limited liability company. The issuer was managed by its Managing Member, which was also a New York limited liability company. In April 2014, the issuer decided to include EB-5 investors and raise funds by selling membership interests to foreign investors who were interested in the program. The Managing Member of the issuer engaged Edwin Shaw, LLC (a firm that is not a registered broker-dealer) to market membership interests to prospective investors. Beginning in April 2014 and up to April 2017, those interests were marketed by the Principal of Edwin Shaw, LLC who would meet with prospective EB-5 investors. At these meetings, there would be a discussion of the prospective investment and detailed information would be furnished. The Respondent was deemed to have violated Section 15(a) of the Securities Act of 1934 when it engaged in the solicitation of investment and purchase of the LLC Membership Interests of the issuer, and otherwise effectuated the securities transactions without being registered with either the SEC or FINRA as a licensed broker dealer.
In fact, the Director of the SEC's New York Regional Office, Mr. Marc P. Berger stated that "While raising money for an EB-5 project in the U.S. Edwin Shaw was not registered to legally operate as a securities broker" and "The registration requirements are crucial to investor protection and we will continue to vigorously enforce them."
Why is this so important?
The Respondent was engaging in the exact type of activities, in an all too familiar structure as most EB-5 private placements that are managed and/or marketed by the majority of the EB-5 industry marketing companies and regional centers. Now, based on this recent ruling, these companies could be deemed to be operating as unregistered broker-dealers. Even with the Respondent, in this case, being a majority owner in the issuer, and the company receiving the EB-5 invested capital, the "go-to - fall back" Issuer Exemption did not provide a safe haven from these SEC sanctions. Quite clearly, the compensation paid directly from the investor's administrative fee was ruled to be illegally earned, as this clearly qualifies as transaction-based compensation resulting from the sale of security. This exact same structure is how every regional center, marketing company, consultant, advisor, and other companies offering similar services are compensated in the EB-5 industry. And it is certainly how broker-dealers are compensated.
The Respondent was ordered to pay a penalty in an amount equal to ALL income that was earned, plus prejudgment interest and a civil monetary penalty totaling over $500,000, for an EB-5 private placement securities offering that involved 30 investors and $15,000,000. Assuming that the majority of the income earned was probably paid to third parties with no chance at any claw-back, the Respondent more than likely received a small portion of the income but is now responsible for penalties that amount to far more. In addition, what is not in the SEC's release is if the investors have taken any action against the issuer, as they are entitled to rescind their investment and demand their investment back, which one would assume includes the administrative fee paid. This legal action would probably be determined by whether or not the investor's immigration application is approved, and then if their investment is returned to them in full. If there is any problem with the immigration application or if the business is unable to repay the investors, the Respondent could have just opened the door for 30 investors to sue them for securities fraud.
What's also unclear is what, if any recourse the Respondent may have against the securities law firm that advised him on his EB-5 securities offering structure and whether or not he was advised by his legal counsel to either use a broker-dealer or become licensed or registered with a broker-dealer as doing so would have clearly prevented this SEC sanction.