Until recently, U.S. offerors and others had to make offerings of EB-5 project investments solely offshore in order to benefit from Regulation S, an exclusion from registration requirements. The offerors had to exclude foreign nationals who were resident in the United States from participation in the project because, under Regulation S, no directed selling efforts could occur in the United States. The separate exemptions that permitted offers to be made in the United States were extremely restrictive, only permitting the issuer, absent costly SEC registration, to make offers to investors that had a pre-existing relationship with the issuer or its placement agent.
New Rule 506(c) permits issuers to make general solicitations in the United States, subject to a number of requirements summarized below. Rule 506(c) states that an offering made pursuant thereto should not be subject to integration with a concurrent offering made pursuant to Regulation S. This means that while the limited partnership interests or other securities offered in the EB-5 transaction are being marketed offshore, those securities may be offered in the United States simultaneously in accordance with Rule 506(c) to those persons who wish to obtain permanent residency under the EB-5 program. As a result, at the same time the offshore solicitations are conducted in accordance with the requirements of Regulation S, a separate offering of the same securities may be made in the United States to prospective EB-5 investors in an offering meeting the requirements of Rule 506(c).
In general, Rule 506(c) permits an offering under Regulation D (a non-registered offering) to be made by means of advertising or general solicitation, including:
traditional forms of advertising (such as newspaper, TV, and radio ads);
web advertising (such as Google Adwords, banner ads, blogs);
email blasts (that must, under separate laws, comply with anti-spam restrictions);
seminars open to the applicable public; and
other forms of networking.
There are a number of requirements applicable to the Rule 506(c) offering that are not requirements of a compliant Regulation S offering. Appendix A provides a high level summary of the requirements of a Rule 506(c), three of which are newly promulgated:
Issuers must take reasonable steps to verify that all investors whose subscriptions are accepted are accredited investors;
Issuers must take reasonable steps to verify that their “Covered Persons” do not have a “Bad Act Event” after September 22, 2013 and to disclose in the offering materials any “Bad Act Event” that occurred prior to September 23, 2013;
According to proposals that are still subject to public comment and that are not yet in effect, issuers would be required to file a Form D with the SEC 15 days prior to first use of general solicitation, submitting copies of general solicitation materials.
The investors in an EB-5 offering will generally be natural persons who are not citizens or permanent residents of the United States. A natural person is an accredited investor if either:
the person had individual income of $200,000 in each of the two most recent years, or $300,000 of joint income with that person’s spouse in each of the two most recent years, and a reasonable expectation of reaching that same income level in the most recent year (the “Income Test”); or
the person has individual net worth, or joint net worth together with the person’s spouse in excess of $1 million, not including the investor’s primary residence or mortgage indebtedness on the residence up to the value of the residence (“Net Worth Test”).
In addition to the requirement that all investors whose subscriptions are accepted in the Rule 506(c) offering must be accredited investors, the issuer is also required to be able to document that it took “reasonable care under the circumstances” to verify that each investor in the Rule 506(c) offering whose subscription is accepted is an accredited investor.
The SEC has stated that the reasonableness of the steps taken to verify that a prospective investor is an accredited investor is affected by:
the type of accredited investor the investor claims to be [for example, whether the individual purports to qualify under the Income Test or the Net Worth Test];
the amount and type of information that the issuer has about the investor [this information would extend beyond the investment funds tracing information required in connection with the investor's immigration petition to such things as a reliable documentation of income (in the case of the Income Test) or substantiation of his balance sheet (in the case of the Net Worth Test)]; and
the manner in which the investor was solicited and the minimum investment amount [typically an EB-5 investment of $500,000 that was not a gift to the investor would tend to support the conclusion that the investor was an accredited investor, even though that alone would not be dispositive].
The SEC has provided certain non-exclusive, safe harbors to satisfy the requirement of reasonable steps to verify the accredited investor status of a natural person seeking to invest in a Rule 506(c) offering:
For the Income Test, review of the IRS forms that report income, including a W-2, Form1099, Schedule K-1 and Form 1040 for the two most recent years, along with a written representation from the individual that he has a reasonable expectation of reaching the qualifying income level during the current year;
For the Net Worth Test, review of one or more of the following types of documentation, dated within the prior three months, and the person’s written representation that all liabilities necessary to calculate his net worth have been disclosed to the issuer:
For assets: bank statements, brokerage statements and other statements of securities holdings and certificates of deposits, and tax assessments and appraisal reports by qualified independent third parties for real property.
For liabilities: a credit report from at least one of the three national consumer reporting agencies.
For the Income Test or the Net Worth Test: Written confirmation from one of the below persons that the person has taken reasonable steps to verify that the investor was an accredited investor on a date within the preceding three months:
a registered broker-dealer;
an SEC-registered investment advisor;
a duly licensed attorney; or
a certified public accountant.
Generally, for EB-5 investors, U.S. tax returns will not be available, nor will U.S. consumer reporting agencies have information concerning the individual’s liabilities. Therefore, either the investor will have to supply third party verification of the type mentioned, or the verification process will have to occur outside any safe harbor.
The Dodd Frank Act mandated disqualification of offers from reliance on Rule 506 (including Rule 506(b) and Rule 506(c)) if any Covered Person had a Bad Act Event. The final rules provide that a Bad Act Event of a Covered Person prior to September 23, 2013 must be disclosed but otherwise is not a show-stopper, while the existence of a Bad Act Event of a Covered Person after September 22, 2013 makes Rule 506(c) inapplicable to the offering.
The burden is on the issuer to take “reasonable care under the circumstances” to determine who are its Covered Persons and whether any of the Covered Persons have a Bad Act Event, and when it occurred. Again, we anticipate that issuers may utilize a knowledgeable external service professional on the team to handle this issue, conduct interviews, collect questionnaires, perform record searches in the appropriate jurisdictions, and prepare a report to the issuer to satisfy the requirement.
Covered Persons include:
each affiliated issuer (for example, a corporate guarantor);
each predecessor to the issuer;
each remunerated solicitor (including brokers and anyone directly or indirectly paid to source investors);
all executive officers of the issuer, the general partners of the issuer and their executive officers and directors;
each holder of 20 percent or more of the voting equity of the issuer; and
all promoters of the issuer (such as the regional center and its executive officers and directors).
Bad Act Events include certain:
restraining orders or cease and desist orders;
final, disciplinary, stop, suspension, or false representation orders;
misrepresentations to the U.S. Postal Service; and
suspensions, expulsions, or bars from various securities self-regulatory organizations.
Proposed Expanded Form D Filing
Nothing is required to be filed with the SEC in connection with the concurrent Regulation S offering, but the SEC has proposed expanded requirements for filing in connection with a 506(c) offering. According to the proposal, 15 days prior to the first use of any general solicitation, the issuer must file with the SEC a Form D that furnishes the SEC with copies of the general solicitation materials. The issuer must update the Form D filing at various times through the conclusion of the offering. You should confer with counsel to ensure all required filings are made as there are penalties for failure to comply.
In the case of both Rule 506(c) offerings, which by their terms are made to accredited investors only, and Regulation S, no particular form of prospectus is mandated, but the anti-fraud provisions of the U.S. securities laws apply to all U.S. issuers. Accordingly, the disclosure to both offshore investors and the accredited investors responding to directed selling efforts in the United States pursuant to Rule 506(c) should:
convey accurately sufficient information about the opportunity and the inherent risks to enable prospective investors to make informed decisions about whether to invest; and
avoid making material misstatements or failing to provide information, the absence of which makes the statements of the issuer of securities materially misleading.
This guidance must be followed not only in preparing your offering circular, but also in your general solicitation materials and electronic media, including websites and social media.
Issuers of securities should provide investors with a written offering circular that states fairly the nature of the project that the issuer plans to develop, the risks of execution, and information concerning the securities offered. An offering circular should contain the major items found in a prospectus, provided that there are no requirements that properly presented financial statements be audited. Note the requirement to include disclosure of any Bad Act Events prior to September 23, 2013 by any Covered Persons.
Especially in connection with Regulation S offerings, where offshore selling agents and referral sources will assist in the distribution, it is important to state prominently in your offering circular that it is the only authorized disclosure document and that investors should not rely upon anything you did not provide directly. Also, the investor’s subscription agreement should contain provisions confirming that investors have not relied on any statements not contained in the offering circular you provided to them.
Written by Carlton Fields