Securities broker-dealer registration requirements and hiring U.S. and Non-U.S. brokers
By Catherine DeBono Holmes, Chair of JMBM’s Investment Capital Law Group and Victor T. Shum, Esq., CEO of the Advantage America EB-5 Group
How EB-5 Regional Centers and Sponsors Can Evaluate Broker-Dealer, Investment Company and Investment Adviser Registration Requirements under U.S. Securities Laws
You may want to read: Part 1 - EB-5 offerings do not fit standard SEC registration requirements.
As mentioned in Part 1 of this article, "EB-5 offerings do not fit standard SEC registration requirements" the Securities and Exchange Commission ("SEC") is studying the EB-5 investment market, but there is no indication whether or when it will issue any guidance regarding the registration requirements applicable to the sale of EB-5 investments. At the May 2014 annual conference of the Association to Invest In the USA ("IIUSA"), the trade association for the EB-5 regional center program, representatives of both the SEC and the Financial Industry Regulatory Association ("FINRA") gave presentations regarding the potential application of registration requirements to EB-5 regional centers and others engaged in the marketing and sale of EB-5 investments, but there was no indication that the SEC or FINRA had developed any policies specifically addressing the unique characteristics of the EB-5 market.
There are exemptions from broker-dealer registration that are available to EB-5 regional centers and entities which act as general partners or managers of EB-5 investment funds. In addition, there are exemptions that apply to non-U.S. broker-dealers in connection with the sale of U.S. securities that could be applied to the sale of EB-5 investments. However, there is a lack of clear guidance specifically applicable to the broker-dealer registration requirements that apply to persons engaged in the marketing and sale of EB-5 investments outside of the U.S. Until such time as the SEC provides specific policies, the EB-5 community is in need of practical advice on how to conduct their business in compliance with U.S. securities laws, and in a way that fits the realities of the EB-5 market.
Based on our experience representing securities issuers, broker-dealers and investment advisers, as well as EB-5 regional centers, EB-5 financing sponsors and developers, here are our suggestions on how EB-5 regional centers and EB-5 offering sponsors can comply with the U.S. securities laws without registration as securities broker-dealers. In addition, here are our thoughts on whether or not to hire a U.S. securities broker-dealer for an EB-5 offering, and whether non-U.S. agents can be hired by EB-5 regional centers and sponsors for offerings conducted outside the U.S.
- The SEC regulates who is required to register as a broker-dealer and FINRA regulates those who are registered as broker-dealers
Before discussing exemptions from registration, here is a brief explanation of the basic regulatory framework for U.S. broker-dealers. The Securities Exchange Act of 1934 requires that persons engaged in the business of transacting securities for the account of others register with the SEC as securities broker-dealers. The SEC's stated policy is to require broker-dealer registration of anyone who receives a commission or other compensation in connection with the sale of securities, unless an exemption is available. Some courts have actually taken a different position on this issue, and have ruled that persons who merely act as "finders" are not required to be registered as broker-dealers. However, the definition of "finder" applies only to someone who does nothing more than make an introduction of an investor, which makes this possible exemption very limited. In order for an entity to become a registered broker-dealer, it is necessary for all of the individual persons associated with that entity and involved in brokering activities to take and pass FINRA examinations requiring extensive knowledge of the U.S. securities laws and regulations, and for the registered entity to adopt extensive written supervisory policies and become a member of FINRA. All members of FINRA (which include virtually all registered broker-dealers) are also required to comply with FINRA's own extensive regulations. Registered broker-dealers are also subject to periodic examinations by both the SEC and FINRA, and to sanctions and penalties if the SEC or FINRA find that either the entity or any registered individuals associated with that entity have violated any of the SEC's or FINRA's regulations. Because of these extensive regulations and requirements, most EB-5 regional centers and sponsors will find it difficult if not impossible to become registered broker-dealers.
- EB-5 regional centers and managers of EB-5 investment funds are eligible for the issuer exemption from securities broker-dealer registration
SEC Rule 3a-4 provides an exemption from broker-dealer registration requirements for the officers, directors and employees of the EB-5 investment fund that sells interests to EB-5 investors, if the conditions for the exemption are met. The same exemption is also available to the officers, directors and employees of the manager of the EB-5 investment fund. There are four general requirements that must be met by each person who uses the exemption, which are as follows: (1) the person must have regular duties other than solicitation of investors, (2) the person may not be compensated for the sale of securities (meaning no commissions or bonuses tied to the sale of investments), (3) the person may not be either currently registered with a broker-dealer or have been registered with a broker-dealer for the past 12 months, and (4) the person may not have been the subject of certain prior disciplinary actions, primarily related to prior violations of the U.S. securities laws or regulations. In addition to meeting these general requirements for the exemption, one of three alternative requirements must also be met: (a) the exempt person solicits only broker-dealers or other designated entities that are themselves engaged in the sale of securities, (b) the person participates in no more than one securities offering every 12 months or (c) the person limits his or her participation in an offering to preparing written offering materials and answering questions of investors. The officers, directors and employees of most EB-5 regional centers and sponsors of EB-5 offerings should be able to qualify for this exemption. For active EB-5 regional centers and sponsors, the most common issue is the limitation on participation to no more than one offering every 12 months. In those cases, it is often necessary for the EB-5 regional center or sponsor to forego the direct solicitation of investors, limiting their participation to discussions with brokers, preparation of written documents and answering investor questions. If this limitation applies, then the EB-5 regional center or sponsor must hire other persons to solicit investors for each of their offerings.
- Hiring a U.S. securities broker-dealer is one way of soliciting EB-5 investors - but it raises practical issues that are problematic in the EB-5 investment market
An active EB-5 regional center or sponsor that conducts more than one offering every 12 months, and thus is limited to preparing written offering materials and answering EB-5 investor questions under SEC Rule 3a4-1, may hire a U.S. securities broker-dealer to conduct the marketing and solicitation of EB-5 investors. That is one way of complying with the securities broker-dealer registration requirements – in other words, if you don't want to be one, hire one. There are some U.S. securities broker-dealers who have some experience in EB-5 investments and are actively seeking to become more involved in this market. However, there are some drawbacks to this alternative. First and foremost, U.S. securities broker-dealers cannot solicit investors directly in China, the largest market for EB-5 investments today. China requires that only licensed emigration intermediary service organizations (中介服务机构) be engaged to participate in the sale of EB-5 investments in China. Moreover, there are few if any U.S. securities broker-dealers who are actively involved in EB-5 investment marketing in China. Second, U.S. securities broker-dealers of course expect to receive a commission for their participation in any offering, but overseas agents are unlikely to agree to reduce their compensation in order to share compensation with U.S. securities broker-dealers, which means that the cost of EB-5 financing would need to be increased to cover the cost of hiring both a U.S. securities broker-dealer and overseas agents. Third, U.S. securities broker-dealer are required to comply with FINRA regulations for every securities offering, including EB-5 offerings, and it is unclear how a U.S. broker-dealer is going to be able to comply with these requirements when they are not directly involved with EB-5 investors, particularly in China.
- U.S. securities broker-dealers are permitted to engage foreign associates and foreign finders and to share offering compensation with them
U.S. securities broker-dealers are generally permitted to share offering compensation only with other registered broker-dealers or registered associated persons of the broker-dealer. However, in 2001, FINRA's predecessor (the National Association of Securities Dealers) adopted a policy, announced in Notice to Members 01-81 (the "NTM"), allowing U.S. securities broker-dealers to pay commissions to so called "foreign associates" of the broker dealer, or finder's fees to unregistered foreign finders. A foreign associate is an individual person who is registered with the broker-dealer by the filing of a Form U-4 for that individual. The NTM does not require a foreign associate to take the FINRA examinations that are required to be taken by U.S. associated persons, but the U.S. securities broker-dealer is required to supervise all of the securities related activities of the foreign associate. Foreign associates can only be persons, not entities. However, since most EB-5 marketing in China is done through licensed agencies, and these agencies control the activities of their employees, it would likely be difficult for a U.S. securities broker-dealer to use the foreign associate model for selling securities in China in particular.
The NTM defines a "foreign finder" as a non-registered foreign person who refers non-U.S. customers to a member firm. The foreign finder exemption would be easier to use, because it does not require the finder to be registered or subject to supervision of the U.S. broker-dealer, but it requires that the U.S. broker-dealer assure itself that the foreign finder is not required to register in the U.S. as a broker-dealer, and that the compensation arrangement does not violate applicable foreign law. However, if a foreign finder is not required to register as a U.S. broker-dealer, and a U.S. broker-dealer is allowed to pay such a foreign finder, then the EB-5 regional center or sponsor can hire foreign finders directly rather than solely through U.S. broker-dealers.
- EB-5 regional centers and sponsors are able to hire non-U.S. brokers to market and solicit investors outside the U.S.
In SECRelease 34-25801 issued in June 23, 1988, the SEC stated that its policy is not to require broker-dealer registration where foreign firms sell U.S. securities exclusively to non-U.S. persons outside the U.S. In fact, the SEC specifically stated in Release 34-25801 that:
"[T]he staff believes that, in contrast to the more expansive scope of the antifraud provisions, the U.S. broker-dealer registration requirements were not intended to protect foreign persons dealing with foreign securities professionals outside the United States. Rather, the primary responsibility for protecting foreign investors from wrongful conduct of foreign securities professionals properly lies with foreign securities regulators."
In Rule 15a-6, the SEC affirmed its policies as explained in Release 34-25801. Based on this policy, U.S. broker-dealer registration is not required for overseas agents who sell securities solely to non-U.S. persons and conduct their selling activities entirely outside the U.S. There may still be some ambiguity regarding whether a foreign broker-dealer would lose its exempt status if it makes visits to the U.S. to conduct due diligence regarding U.S. projects, or it chaperones foreign EB-5 investors to visit project sites and conduct their own due diligence. In our view, these are not the types of activities that should cause a foreign broker-dealer to lose its exemption from broker-dealer registration under U.S. securities laws. Nonetheless, it would be helpful if the SEC would issue specific guidance on the types of activities that may be undertaken by overseas agents and by in connection with EB-5 offerings.
As explained above, the SEC's existing policies allow EB-5 regional centers and sponsors to hire foreign broker-dealers to sell EB-5 offerings outside the U.S. to non-U.S. persons. Therefore, as long as the foreign broker-dealers do not conduct activities in the U.S. that would cause them to lose their exemption from registration, EB-5 regional centers and sponsors are not legally required to hire a U.S. broker-dealer to conduct EB-5 offerings outside the U.S. In fact, SEC Rule 15a-6 allows a foreign broker-dealer to sell U.S. securities to non-U.S. persons who are temporarily in the U.S. There is no explanation of what is meant by "temporarily in the U.S.," but it might be interpreted to include a non-U.S. person who resides in the U.S. on a temporary visa, such as a student going to school in the U.S. on an F-1 student visa. It would be helpful if the SEC would issue specific guidance on this issue.
- How EB-5 regional centers and project sponsors can protect themselves against claims of U.S. securities law violations
EB-5 regional centers and project sponsors who do not wish to register as securities broker-dealers should conduct an analysis of their business and determine how they will comply with the exemption from registration under SEC Rule 3a4-1. They should also determine whether they wish to hire a U.S. securities broker-dealer, and if so, whether they would hire the U.S. broker solely for sales to persons residing in the U.S., or for the entire offering. In addition, they should determine whether to hire foreign broker-dealers for sales of securities outside the U.S., and if so, how they will confirm that the foreign broker-dealer is exempt from registration under U.S. securities laws. Our recommendation is that the EB-5 regional center or sponsor document their policies in writing, so that if the SEC or anyone else asks what their policies are, they are able to present their analysis and reasons why they are exempt from registration. We would welcome the SEC providing clearer guidance on these issues, but in the meantime the SEC's existing policies can be used to structure EB-5 offerings without the need for registration as a securities broker-dealer or for the hiring of U.S. securities broker-dealers.
Check back soon for our next article in this series.
Catherine DeBono Holmes is the chair of JMBM's Investment Capital Law Group, and has practiced law at JMBM for over 30 years. She specializes in EB-5 immigrant investment offerings and hotel and real estate transactions made by Chinese investors in the U.S. Within the Investment Capital Law Group, Cathy focuses on business formations for entrepreneurs, private securities offerings, structuring and offering of private investment funds, and business and regulatory matters for investment bankers, investment advisers, securities broker-dealers and real estate/mortgage brokers. Contact Cathy at [email protected] or +1.310.201.3553.
Victor T. Shum is the Chief Executive Officer of the Advantage America EB-5 Group, Advantage America California Regional Center, LLC and Advantage America New York Regional Center, LLC. He was previously a corporate and securities partner at the law firm of Jeffer Mangels Butler & Mitchell LLP. Victor has significant experience advising clients on cross-border transactions, including representing investors and companies in inbound and outbound technology and real estate transactions with China, and representing high-net worth individuals, real estate developers and USCIS regional centers with the EB-5 immigrant investor program, a topic in which he is a frequent publisher and speaker. Contact Victor at [email protected] or +1.510.808.7466.
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