EB-5 Securities Exemptions
by Jor Law, Esq.
To be eligible for an EB-5 visa, immigrant investors generally invest in the securities of the companies or projects that promise them a green card in exchange for their investment. As such, EB-5 investments are subject to US securities laws, both federally and at the state level.
Securities laws exist to protect investors. The primary method of protecting investors is by ensuring that investors have adequate information to make investment decisions. To achieve this objective, securities laws generally provide that any offer to sell securities must first be either registered or qualified with the appropriate governmental body or satisfy an available exemption. This is a process which is extremely time-consuming and costly. Accordingly, those who raise capital generally seek an exemption to the securities laws instead.
In the EB-5 regional center space, the two most common securities exemptions relied upon have historically been Rule 506(b) and Regulation S (“Reg S”). This article explores those exemptions as well as the new Rule 506(c) exemption that many attorneys are advising their clients to consider and the newly modified Rule 504 exemption.
Reg D contains three rules (Rule 504, Rule 505, and Rule 506) providing differing exemptions from the registration requirements. Rule 504 has limited but very important applications which are discussed below. Rule 505 is being repealed on May 22, 2017 and will not be discussed in this article. Rule 506 contains two separate exemptions which this article will highlight: Rule 506(b) and Rule 506(c).
Rule 504 is rarely used in the EB-5 industry. In fact, it is not frequently used outside of EB-5 as well. It is an exemption that most people shied away from because historically it only allowed a maximum capital raise of $1,000,000. Additionally, it is only a federal exemption, so someone that relies upon the Rule 504 exemption separately needs to find state exemptions for each state that their securities offering touches. In EB-5, most companies, and their attorneys, are unfamiliar with Rule 504. But, with recent modifications, Rule 504 is actually extremely powerful in the EB-5 context.
Recall that one of the primary limitations on Rule 504 is that it is only a federal exemption. In domestic offerings not involving EB-5, it is common for an offering to span across many states. Having to find separate exemptions for each of the states was rather onerous, especially given that the maximum capital raise was $1,000,000.
In EB-5, however, since all the investors generally are overseas, there is generally only one state (the state of the issuer’s primary place of business) that companies need to find an exemption for. Also, as of January 20, 2017, the $1,000,000 limit was raised to $5,000,000. So why is this exciting? Because Rule 504 can be used to accept investments from US Persons (which Reg S cannot) and non-accredited investors (which Rule 506(b) and Rule 506(c) cannot). Smaller offerings that have a need to target non-accredited investors and investors residing in the US may want to consider a Rule 504 capital raise.
The king of all capital raises is Rule 506(b). Each year, over a trillion dollars of capital is raised through the Rule 506(b) exemption. The primary attraction of Rule 506(b) is that it not only is a federal exemption, but it also preempts state securities laws. A company that offers securities under Rule 506 may avoid having to register or qualify the securities under state laws.
In order for an offering to rely on the Rule 506(b) exemption, certain criteria must be met, which generally include: (1) limitations on general solicitation or advertising used to market the securities (e.g., no radio shows, newspaper advertisements, or seminars to the public); (2) requirements on the type of investors permitted (e.g., unsophisticated investors are not allowed); (3) a cap on the number of certain types of investors (e.g., no more than 35 unaccredited investors); (4) disclosure obligations that vary based on the type of investors solicited (e.g., significant disclosure obligations if soliciting unaccredited investors); (5) significant restrictions on transferability of the securities being issued (generally includes minimum hold periods at the very least); and (6) filing of a Form D notice with the SEC.
The primary downside of Rule 506(b) is that it may only be used for private offerings because no general solicitation and advertising is allowed. 506(b) offerings must be painstakingly conducted through private networks only. Rule 506(b) has certain limitations in EB-5 as many companies do not have private networks containing many EB-5 investors.
Rule 506(c) retains almost all of the benefits of Rule 506(b) while allowing general solicitation and advertising of the securities being sold. Like Rule 506(b), Rule 506(c) preempts state securities laws. However, Rule 506(c) allows for general solicitation and advertising of the offering. The trade-off, however, is that all investors must be accredited investors, and they must prove it. In the EB-5 industry, however, most investors are accredited investors anyway. Additionally, EB-5 investors are used to providing evidence to support their EB-5 application, so the added requirement of accredited investor verification found in Rule 506(c) does not constitute much additional burden.
Rule 506(c) is a relatively new securities exemption, having only been in effect since September 13, 2013. However, in the EB-5 industry, it is starting to see increased usage as companies take advantage of Rule 506(c)’s ability to generally solicit and advertise and accept investors who reside in the US. Many securities attorneys familiar with the EB-5 space have suggested that Rule 506(c) is the primary or only securities exemption companies ought to consider using when raising EB-5 capital.
Reg S exempts offers and sales of securities “that occur outside the United States”. In short, the Reg S exemption is useful when all the offers and sales activities are completed entirely offshore and made only to non-US Persons.
The limitation of Reg S is that it is only a federal exemption. A company that relies on Reg S must separately seek a state securities exemption. Additionally, Reg S not only prohibits investments from US Persons, but companies may not condition the US market as well. That means no hosting investment seminars in the US; no taking booths to market your offering at US based trade fairs, etc.
It’s possible for a company to simultaneously conduct a Reg S and a Reg D (either Rule 504, 506(b), or 506(c)) offering. Careful attention must be paid to the method of offering and sale of the securities to make sure that the offering is in compliance with all of the conditions of each exemption it hopes to rely upon. It’s best to consult with a securities attorney experienced with the interplay between Reg D and Reg S. There may be situations where relying on a single exemption is superior to attempting to utilize multiple exemptions.
Properly compliance with the exemptions is crucial. It is extremely important to understand what you can or cannot do with each exemption. Talk with a qualified securities attorney who understands the EB-5 industry before you solicit investors so that you do not accidentally take an action that disallows you from using a certain exemption. If you are unable to rely on any exemption, then your offering would require registration, which would be prohibitively expensive and time-consuming for almost all EB-5 capital raises.
Jor practices corporate and securities transactional law in Los Angeles and is a founding shareholder of Homeier Law PC. Jor maintains a broad-based general corporate legal practice with an emphasis on mergers & acquisitions and finance. He is most well-known for his expertise in alternative finance, including EB-5 finance and crowdfunding, both industries where he is recognized as one of the foremost and influential transactional attorneys in the world. In addition, Jor is a co-founder of VerifyInvestor.com, the resource for accredited investor verifications trusted by broker-dealers, law firms, companies, and investors who insist on safety and reliability. VerifyInvestor.com is the dominant provider of outsourced accredited investor verifications in the crowdfunding and EB-5 industries.
 Technically, Rule 506(b) does allow non-accredited investors. Practically speaking, most companies avoid non-accredited investors anyway due to heightened compliance burdens if they accept them.
 Note, however, that the preemption does not affect all types of securities or all types of person. Additionally, while an issuer may not have to register or qualify the securities under the various states’ securities laws, it may still be required by some states to pay certain fees and make notice filings.