On Oct. 21, 2024, the Securities and Exchange Commission (SEC) Division of Examinations issued its annual report for its inspection priorities for the upcoming year.
There were two things of note among many others. First, the EB-5 visa program was not specifically mentioned by the SEC as a target of increased inspection scrutiny. That certainly makes sense given the audit and inspection obligations imposed by the recent reforms to the EB-5 program. Second, and quite prominent, there were discussions about the implementation and enforcement by broker-dealers of compliance procedures for Regulation BI.
The discussions generally echo the Commission’s emphasis on protecting retail investors by providing balanced risk presentations at the point of sale and throughout the retail client’s relationship with their financial services provider.
This regulatory scheme has been around for a while, and the securities industry has been quite vocal regarding not only compliance obligations but the standards of care it imposes. A cursory review of the FINRA “checklist” for Regulation BI compliance by broker-dealers is a stark reminder as to why. The devil is purely in the details here, as the “zinger” for those in the EB-5 industry is the definition used by Regulation BI for a “retail investor.” You may be surprised to learn that the “retail investor” of Regulation BI is not subject to the same dichotomy as an “accredited investor” under Regulation D. In fact, a review of Regulation BI, and recent enforcement actions by the Financial Industry Regulatory Authority (FINRA) this year, make it very clear that a “retail investor” includes a “natural person,” notwithstanding their status as accredited or non-accredited in the context of Regulation BI. Thus, one who may invest in EB-5 securities is a “retail investor” for purposes of Regulation BI.
WHAT DOES THIS HAVE TO DO WITH EB-5?
Remember, however, that Regulation BI addresses the compliance obligations of broker-dealers specifically. Luckily (or intentionally), the definition of “broker-dealer” under Regulation BI appears to relate back to those definitions within the 1934 Act (including Section 15, in which Regulation BI resides) that require that entity to be registered as a broker-dealer.
So those who are exempt from the “broker-dealer” definition would appear not to have Regulation BI obligations. Suffice it to say that those looking to punish an unregistered broker-dealer violating its registration regulations have plenty of other tools at their disposal to impose liability.
ENSURING TRANSPARENCY IN EB-5 INVESTMENTS UNDER REGULATION BI
Thus, what Regulation BI does mean for the EB-5 industry is that those projects that utilize a broker-dealer for distribution need to ascertain whether (a) that broker-dealer has a robust Regulation BI compliance program in place and (b) whether it wants to accede to the transparency that Regulation BI would appear to require of issuers. That is, the information a broker-dealer is going to require of an EB-5 issuer at not only the point of sale but thereafter as to the likelihood of repayment and satisfaction of requirements under the immigration laws of the United States, assuming, of course, that the broker-dealer communicates with the EB-5 investor as Regulation BI intends.
Another looming issue is that selling agreements often have indemnity clauses that are triggered in the event of a lawsuit. Mutual indemnity for Regulation BI violations makes no sense to an EB-5 project or regional center. Theoretically, the standards of care imposed upon broker-dealers are so high under Regulation BI that even those placing EB-5 investments that ultimately meet their repayment and immigration goals could be subject to liability for failure to provide a less costly alternative. Should the financial burden for legal liability then be borne by the issuer?
There are other equally imposing yet circular deficiencies that one broker-dealer can create with a shoddy compliance program that could trigger liability for violating the standards of care imposed by Regulation BI. And for the small number of states that have sought to impose fiduciary duties on broker-dealers generally, one can safely surmise that Regulation BI serves as the bearing by which those duties will be evaluated.
REGULATION BI IMPROVES PROTECTION OF EB-5 INVESTORS
While there has always been a healthy debate about the use of broker-dealers in the EB-5 industry, those working with broker-dealers not only need to review Regulation BI policies and procedures in place, but also selling and placement agent agreements as well to specifically address indemnity for Regulation BI obligations. From an issuer’s standpoint, if subscription agreements specifically address the use of broker-dealers, disclosures regarding their obligations under Regulation BI may be worth considering.
What is clear is that the SEC is emphasizing compliance with Regulation BI to protect the investing public from abusive recommendations and uses of illiquid, privately placed securities. Those in the EB-5 industry who rely on FINRA-member broker-dealers for placement of their products must realize that Regulation BI also protects immigrant investors as well.
Robert V Cornish Jr
Robert Cornish is a securities litigation attorney serving EB-5 investors and market participants who applies his front-line perspectives as a compliance officer and counsel for funds, broker-dealers and investment managers. Cornish has experience in litigating in state courts, federal courts and arbitration forums such as FINRA and AAA. In addition, Cornish is a certified mediator who can propose and navigate alternative paths to costly litigation.
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