Limiting Securities Litigation Risks In EB-5 Offerings: What Regional Centers And Issuers Need To Know

The flurry of federal suits filed by the U.S. Securities and Exchange Commission (SEC) in the past few months against several companies and individuals for alleged fraud and false statements in soliciting foreign investors under the EB-5 Immigrant Investor Program shows that the government is taking a tougher approach to enforcement in the EB-5 space. Recent SEC suits include SEC v. Luca International Group, LLC, SEC v. Path America, LLC, SEC v. EB5 Asset Manager, LLC and SEC v. Robert Yang et al. Although the SEC's complaints in these cases describe extreme situations involving the defendants' misuse of investor funds to fund their own personal purchases, the securities laws invoked by the SEC have broad coverage and can be used to sanction less egregious conduct. Indeed, in some cases merely negligent misstatements to investors can trigger liability.

The SEC's principal claims in the cases referenced above were brought under the primary anti-fraud provisions in the federal securities laws - Section 17(a) of the Securities Act of 1933 (15 U.S.C. § 77q(a)), and Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)), as implemented by SEC Rule 10b-5 (17 CFR § 240.10b-5). These are not the only enforcement statutes in the federal securities laws, of course, but they are the broadest and most commonly used. This advisory outlines the key provisions of these laws as they may be applied to EB-5 investments. In addition to explaining how civil anti-fraud statutes apply in the EB-5 context, we also offer guidance to regional centers, broker-dealers and issuers of EB-5 securities on how to mitigate risks of future litigation in the specific area of securities fraud.

Background on EB-5 projects and the securities laws

Administered by U.S. Citizenship and Immigration Services (USCIS), the EB-5 Immigrant Investor Program offers foreign investors an opportunity to secure permanent residency in the United States by making a capital investment in a commercial enterprise that will create or preserve at least 10 jobs for U.S. workers. The minimum investment is $1 million per investor, or $500,000 for an enterprise that creates jobs in a Targeted Employment Area (TEA), which is defined as a rural area, or as an area that has an unemployment rate that is at least 150% of the national average.

Promoters of EB-5 projects need to be aware that the investments they are offering to foreign nationals are frequently structured as a type of security that is subject to federal and state securities laws. In particular, the terms "security" and "securities" are very broadly defined in the Securities Act and Securities Exchange Act to include not only traditional stocks and bonds but any "investment contract," among other items. See 15 U.S.C. § 77b(a)(1); 15 U.S.C. § 78c(a)(10).1 The U.S. Supreme Court has in turn interpreted "investment contract" to mean "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party." SEC v. Howey Co., 328 U.S. 293, 298-299 (1946). Under that broad definition, most EB-5 investments, apart from those where the investor is actively involved in the management of the enterprise, would constitute a form of security.

Consequently, even though the investments offered in EB-5 projects are typically not publicly traded and are usually exempt from SEC registration requirements, they may still be subject to the anti-fraud provisions in Section 17(a), Section 10(b), and Rule 10b-5. The registration exemptions available under Section 4 of the Securities Act (15 U.S.C. § 77d) and SEC Regulation D (17 CFR § 230.501 et seq.), for example, do not shield exempt securities from claims under Section 17(a), Section 10(b), and Rule 10b-5.2

What do Section 17(a), Section 10(b), and Rule 10b-5 prohibit?

Generally speaking, Section 17(a), Section 10(b), and Rule 10b-5 prohibit the use of fraudulent schemes or practices, untrue statements of material facts, or misleading omissions of material facts, in connection with securities transactions. Rule 10b-5 provides that:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

To employ any device, scheme, or artifice to defraud, To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. The language in Section 17(a) is similar, although there are some significant differences discussed below.

What is a material fact?

Litigation under Section 17(a) and Rule 10b-5 commonly involves claims that the issuer or a related party made misstatements or misleading omissions of material facts. Section 17(a)(2) and Rule 10b-5(b) both prohibit use of "any untrue statement of a material fact" or any omission of "a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading." But what is a material fact?

The Supreme Court has said that a fact is material where there is a substantial likelihood that it would be viewed by the reasonable investor as having significantly altered the total mix of information made available. See Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1318 (2011). In Matrixx, for example, the Court held that adverse reports about a serious side...