A recent clarification of a United States Securities and Exchange Commission (SEC) rule could improve how EB-5 issuers offer their projects to potential EB-5 investors.
The explanation involves Rule 506(c) of Regulation D of the Securities Act of 1933. The clarifying update simplifies the process of verifying investors, shortens the onboarding duration, and enhances access to capital for issuers making fund offerings. It lessens compliance constraints and establishes clearer criteria for private placements and the accreditation of private investors.
While the update does not focus solely on EB-5 investments, it affects EB-5 issuers by streamlining their capital-raising process and enhancing their access to accredited investors, which includes EB-5 investors.
EB-5 issuers are entities or individuals who offer investment opportunities to foreign investors seeking U.S. permanent residency through the EB-5 Immigrant Investor Program. They typically create projects or businesses that qualify for EB-5 investment and comply with the program’s requirements.
What is rule 506(c) and what changed?
Rule 506(c) allows companies in the U.S. to raise capital through the sale of securities to accredited investors while permitting general solicitation and advertising. This rule was introduced in 2012 as part of the Jumpstart Our Business Startups (JOBS) Act to facilitate access to capital for startups and small businesses.
Ronald Fieldstone from Saul Ewing, LLP, explains,: “Congress directed the SEC Commision in Section 201(c) (j) of the Jobs Act of 2012 to allow securities offerings to do general solicitation pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. As a result, the securities industry utilized this method to raise capital, but the issue of determining whether an investor is accredited was now placed on the issuer of the securities and not on the investor, unlike the Rule 506(b) exemption, where general solicitation is not involved.”
Securities attorney Debdie Klis from Rimon P.C. notes that this rule altered “80 years of restrictions on general solicitation and advertising in private offerings in the U.S.” Since its enactment 13 years ago, this provision has allowed issuers to “solicit investors by generally advertising their private offering if all investors are accredited investors and the issuer takes reasonable steps to verify purchasers’ accredited investor status,” she adds.
However, to meet the “reasonable steps” obligation, issuers had to confirm an investor’s income or net worth by examining tax returns, bank statements, or brokerage statements or by obtaining written verification from an attorney, certified public accountant (CPA), or broker affirming that the investor qualified as an accredited investor.
This authentication could become burdensome for investors, Klis says. “Because of these burdens along with the uncertainty whether the SEC would consider their verification procedures satisfactory, most EB-5 funds (NCE) have not relied on the Rule 506(c) exemption to advertise and generally solicit investors in the United States who are already here under another visa program.”
The recent clarification eliminates the requirement for issuers to verify investors’ income or net worth through documentation. Instead, investors can self-accredit by completing a questionnaire, simplifying the process for both issuers and investors.
Fieldstone adds that the SEC confirmed that “the size of the investment is a major factor in determining the investor self-accreditation. For instance, if an investor invested $1 million in an investment, accreditation would be automatic, assuming the investment was not financed, and the issuer has no knowledge to the contrary.”
How does the update affect EB-5 investments?
The modification benefits EB-5 issuers by easing accredited EB-5 investor verification requirements. These investors can now self-accredit by completing a questionnaire, reducing the need for third-party verification.
Attorney Phuong Le from KLDP, LLP, explains that the modification benefits EB-5 issuers by easing their accredited EB-5 investors’ verification requirements and streamlining the process. This makes it easier for them to onboard accredited EB-5 investors.
“Instead of going through a third party, such as a CPA or attorney who must review their assets before accrediting, EB-5 investors will effectively self-accredit by completing a questionnaire. Issuers can rely on self-accreditation (unless they have reason to believe otherwise),” Le says.
Klis adds: “In simple terms, the NCE should include in their subscription agreement for U.S.-based investors: (1) a written representation that the [EB-5] investor is an accredited investor; and (ii) that the [EB-5] investor did not finance the minimum investment amount by a third party.”
Meanwhile, Fieldstone recommends that the EB-5 subscribers questionnaire provide for “a confirmation from the investor that they did not finance the investment, and the investor should confirm the additional assets owned to add to the investment made in the NCE fund, including the administrative fee, filing fee and legal expenses.”
The securities lawyer also notes that, according to the update, “the larger the investment, the easier it is to self-certify.”
Nonetheless, Klis cautions that there is an important condition.
“The caveat here is that if the NCE relies on Rule 506(c) to advertise and generally solicit investors in the U.S., then all investors who are based in the United States must be accredited without exception since it would be impossible to distinguish who invested in reliance on the advertising and who did not.”
The change adds to other measures established by the Reform and Integrity Act of 2022 to protect EB-5 investors and ensure the safety of the projects offered by NCEs and regional centers.
“Investor protection remains paramount of course, but it’s a sign that the SEC is shifting their resources to overseeing other areas like fraud in offerings or brokers,” Le concludes.
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