United States: EB-5 Securities Law Disclosure Obligations And Possible Marketing Opportunities In The Wake Of The Recent Modernization Rule

Seyfarth Synopsis: This article discusses the impact of the newly adopted EB-5 regulations on the disclosure obligations of ongoing EB-5 offerings.

The obligation to make full and fair disclosure under the US federal securities laws is most often viewed by many, if not most sponsors who are seeking EB-5 capital as a legal and regulatory burden – sometimes almost as a necessary evil. Moreover, many also assume that a given legal development, such as the new EB-5 rule published late last July, will simply require essentially the same disclosures for every EB-5 financing being launched or currently in the offering process.

The reality is very different. Not only must disclosures be crafted to be consistent with each offering's dynamics, needs and stage of offering, marketing and development, but required disclosures can often, without in any way impairing accuracy, compliance with law, and the need for the securities law professionals advising clients to offer impartial unconflicted advice and counsel, enhance the marketing of the offering.

To illustrate how this can be accomplished, consider how each of the following three hypothetical on-going offerings could reasonably address disclosure obligations in the wake of the recently published EB-5 Modernization Rule (the "Rule"), which is to become effective November 21, 2019. Click here for a summary of the Rule.

Hypothetical Offering A: Commenced offering in June 2018, and has closed on investor subscriptions (with accompanying I-526 petitions filed) representing 80% of its targeted offering amount. The unsubscribed 20% is required to complete the project. The underlying project is located in a census tract which previously qualified as a TEA, but the sponsor believes (and has a reasonable and documentable basis for such belief) that the project will continue to qualify as a TEA under the New Rule.

Hypothetical Offering B: Commenced offering in December 2018, and has closed on investor subscriptions (with accompanying I-526 petitions filed) representing 100% of its targeted offering amount. The company wishes to increase the size of the offering and use the additional funds to replace other components of its capital stack. The underlying project is located in a census tract which previously qualified as a TEA, but the sponsor believes that the project will not (or that there is substantial doubt as to whether the project will) qualify as a TEA under the New Rule.

Hypothetical Offering C: Commenced offering in March 2019, and has closed on investor subscriptions (with accompanying I-526 petitions filed) representing only 35% of its targeted offering amount. The unsubscribed 65% is required to complete the project. The underlying project is located in a census tract which previously qualified as a TEA, but the sponsor believes that the project will not qualify as a TEA under the New Rule.

How should (or could) each of these offerings address (a) disclosure obligations, and (b) any need for, or how best to avoid rescission offers under the securities laws? The questions a securities attorney needs to evaluate include:

• Is a supplement to the offering's current offering/disclosure documents required to be distributed?
• What risks should that supplement describe?
• Must a rescission offer be made to those investors whose subscriptions were accepted and funded?
• How should the securities attorney and his/her client address the requirements of the New Rule that the "[petitioner investor have] no right to withdraw or rescind the investment....at the time of adjudication of the petition." 8 CFR § 204.6(n)(3).

The three hypothetical offerings share the following characteristics:

• The offerings are ongoing.
• The offerings may remain open after the effective date of the New Rule.
• Each investor who has invested in an offering to this point has filed their I-526 petitions and accordingly their petitions should be adjudicated under the existing rules.

The primary differences between the offerings are:

• Hypothetical Offerings A and C have not yet raised their initial targeted amounts and need additional funds to complete their respect projects.
• In Hypothetical Offerings B and C, the issuer is assuming that the project will not be deemed to be located in a TEA under the new rules.

Existing Investors. With respect to the possibility of rescission as regards existing investors, there are two potential grounds for requiring rescission: (i) a material change in the terms of an investor's investment, if not approved by the investor, or (ii) a material deficiency in the disclosure documents given to the investor at the time of their initial investment. Since the New Rules do not apply to I-526 petitions filed prior to the effective date of the New Rules, the general terms of the investments made by the existing investors should not change. The investors should continue to be deemed to have invested in a TEA and be subject to a $500,000 minimum investment. As long as the initial offering document was appropriately drafted, with disclosure of risks both relating to the possibility that the issuer would be unable to raise the full amount ("Offering Completion Risk") and to the possibility of changes to the terms of the EB-5 program ("Program Change Risk"), an investor should not be able to claim that they were inadequately warned of what could happen. In short, existing investors should not be entitled to rescission as a result of the New Rules.

If (while unlikely) sponsor and legal counsel were to conclude (perhaps with the benefit of hindsight) that existing disclosures were inadequate to fully address Offering Completion Risk or Program Change Risk, a rescission offer would be appropriate. In that event, counsel would want to ensure that a full and knowing waiver of all rescission rights was obtained from each existing investor. That waiver would need to be rapidly drafted, communicated and obtained in a manner that ensured its effectiveness both under both (a) applicable securities laws and (b) the New Rule. It is not crystal clear (although one might hope) that compliance with (a) will constitute compliance with (b).

Subsequent Investors. Since the New Rules both potentially change the terms of an offering for subsequent investors and increase the risks involved with the offering by making it more difficult to raise capital, a supplement is warranted in all three of our hypothetical offerings. The content of the supplement may vary somewhat among the offerings, as described below.

Hypothetical Offering A:

• Indicate that the minimum investment amount will increase to $900,000 (the new minimum for investing in a TEA) for investors who do not file their I-526 prior to November 21, 2019.
• Indicate that the New Rules will make it more difficult to raise funds from EB-5 investors and discuss the impact on the project of failing to raise sufficient funds. The disclosure would be in the nature of a refinement of existing disclosure of Offering Completion Risk.

Hypothetical Offering B:

• Indicate that the minimum investment amount will increase to $1,800,000 (the new minimum for investing in a TEA) for investors who do not file their I-526 prior to November 21, 2019.
• Address any impact the increased offering size will have on job creation estimates.
• Since the issuer does not need the additional funds to complete the project there should be no need for additional disclosure of Offering Completion Risk – i.e., no need to indicate that the New Rules will make it more difficult to raise funds from EB-5 investors and discuss the impact of failing to raise sufficient funds on the project. If, however, the issuer touts benefits to the investors of the expanded offering size, some discussion of these matters may be warranted to indicate that the benefits may not be achieved.

Hypothetical Offering C:

• Indicate that the minimum investment amount will increase to $1,800,000 (the new minimum for investing in a TEA) for investors who do not file their I-526 prior to November 21, 2019.
• Indicate that the New Rules will make it more difficult to raise funds from EB-5 investors and discuss the impact on the project of failing to raise sufficient funds. The disclosure would be in the nature of a refinement of existing disclosure of Offering Completion Risk.

As addressed in the discussion of Hypothetical Investment B above, if an issuer does not need additional funds to allow completion of a project, there is less need to discuss the added risks created by the New Rules with respect to capital-raising. However, as making investors aware of the pending increase in minimum investments may give investors an additional incentive to make investment decisions quicker, there are likely marketing benefits to updating offering documents to include this disclosure where the offering will remain open. Some sponsors of existing ongoing EB-5 offerings are already reporting an uptick of investor interest spurred by the New Rules.

In conclusion, while the New Rules warrant updating the offering materials for most ongoing offerings, if the initial materials were properly prepared, there should be limited impact on the offerings beyond making the updates. The changes in the EB-5 rules should not give rise to rescission claims from initial investors. In fact, rather than giving existing investors a way out of the funds, in the short term, the New Rules should provide sponsors engaged in ongoing offerings with an enhanced marketing "pitch" to new investors to expedite their investment decisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.