Steps to Take Now to Avoid the EB-5 Dragnet

By Les Gold, and Mark Hiraide

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The Securities and Exchange Commission (SEC) is keeping an eagle eye on EB-5 projects these days, as evidenced by a dramatic increase in the number of fraud cases the agency has filed in federal courthouses across the country.  EB-5 refers to the type of visa the government issues to immigrants who invest large sums in U.S. commercial projects that create or maintain a minimum of 10 jobs.

After filing only one EB-5 fraud case in 2014 and two the year before, the SEC filed five EB-5 fraud cases in 2015 and another two so far this year.  MSK’s Corporate & Business Transactions attorneys, who practice in this area of law, are noticing that most of these cases accuse issuers of EB-5 offerings of defrauding foreign investors by making misrepresentations in securities offering documents.

Not only does MSK assist clients in preparing EB-5 offering documents,  we also defend issuers in SEC enforcement actions.  MSK attorneys are currently representing the defendant in two high-profile EB-5 fraud cases, filed in 2015 and 2016We also counsel our clients on how to best conduct their EB-5 offerings and operate their EB-5 projects to comply with the law and avoid the SEC’s heightened scrutiny.

Here are four key issues that require particular attention:

    1. To update or not to update?  You’ve finally completed that offering disclosure document or “PPM,” and you’re good to go, right?  Well, yes, until the time comes when you must answer one of the most difficult issues in EB-5 securities offerings — when do offering documents need to be supplemented or updated?  EB-5 offerings typically are best-efforts offerings that remain open for a continuous period of time.  As time passes and circumstances relating to the EB-5 project change, you must determine whether securities laws require you to supplement or update your offering documents.

An essential requirement of the securities anti-fraud rules is that an issuer shall not make any untrue statement of a material fact to its investors or omit a material fact if such omission causes the issuer’s other statements to the investors to be misleading.  If you have continuously offered EB-5 investment securities for a long period of time, certain statements in your original offering documents may have become outdated and inaccurate.  Disclaimers in the offering documents that you have no duty to update the information will not protect you from charges of securities fraud.  If you intend to continue with the offering, you should discuss with your securities counsel the changes to your EB-5 project since the launch of your EB-5 offering and evaluate the materiality of those changes.  If any of those changes can potentially cause a negative impact on the investors’ investment return and/or immigration prospects – for example, a significant delay in the project’s timeline or a substantial increase of the project budget, such changes are most likely material and need to be disclosed in updated offering documents (e.g., a supplement to the original offering documents).  To avoid the risks of committing securities fraud, if material changes have occurred, you should immediately stop using the original offering documents and make necessary updates to those original offering documents before distributing them to new investors.  In some cases you may be required to provide the updated offering documents to existing investors as well and seek their affirmation of their existing investments in the EB-5 project.

  • Follow the money.  Ensuring that you have used EB-5 investor funds as disclosed in your offering documents and solely for the purpose of the EB-5 project — and have proper financial records to verify the proper use of the investor funds — is critically important.  The SEC’s EB-5 fraud investigations tend to focus on the actual use of proceeds from an EB-5 offering and whether they have been applied in accordance with the offering documents and the business plan provided to investors.  If any EB-5 investments (i.e., the $1 million or $500,000 capital investment required under the EB-5 Program) have been used to pay for the issuer and/or its affiliates’ personal expenses, other projects, or for other purposes not disclosed in the offering documents, such uses will be closely scrutinized by the SEC and are most likely to lead to an SEC anti-fraud enforcement action against the issuer.
  • Related-Party Transactions.  It is not uncommon in this sector for an EB-5 issuer to use bridge financing from affiliated entities to fund the EB-5 project while waiting for EB-5 investment funds.  The EB-5 issuer may also conduct other transactions with its affiliated entities.  The securities rules do not prohibit such practice; however, information about the related party transactions and their basic terms in most cases is deemed “material” and should be disclosed to the investors.  If your original offering documents do not include full and up-to-date disclosures of the related party transactions, we strongly recommend that you make such disclosures in the updated offering documents.
  • Payment to Promoters and Other Agents.  A complex area of securities laws relates to whether and under what circumstances an issuer may compensate a third party for soliciting or introducing investors to the issuer.  Issuers must ensure that they comply with all applicable securities rules, including the rules relating to the licensing of brokers and finders.  Although we have observed that the SEC investigations and lawsuits against EB-5 issuers focus on fraud claims, there is no doubt that the EB-5 issuers need to comply with all other applicable securities rules, including the rule that prohibits using or paying success-based commissions to unregistered broker-dealers to promote the sales of the EB-5 securities in the U.S.

If the SEC initiates an investigation of an EB-5 project and brings an enforcement action against the issuer, the issuer and the persons who control the issuer may be personally obligated to refund investors’ monies and could be required to pay additional monetary penalties.  Not only will the issuer’s reputation likely be tarnished, but if the issuer is found liable for violating the securities rules, the investors will have a rescission claim and may be able to recover their investment, not only from the issuer, but also from the issuer’s controlling persons.  Given the potential legal liabilities that may result from violation of securities rules including, the use of outdated offering documents which misrepresent material facts, we strongly recommend that if you intend to continue with your EB-5 offering, you should seek professional evaluation of your offering documents and if necessary, update and supplement the offering documents.  We also recommend that you seek a professional opinion if you are concerned that any aspect of your EB-5 offering may have violated any securities rules.

We are prepared to assist you in evaluating your offering documents and procedures to help you avoid any potential risk of securities law violations related to your offering, and to suggest possible remedial measures if necessary.

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