International Law and Immigration
Risk Factors in EB-5 Regional Center Private Placement Memoranda
By William Tolin Gay*
The EB-5, or immigrant investor, visa provides a means for wealthy foreigners to invest in a new business enterprise in the United States, create jobs, and thereby obtain the right to permanent residence. For many years, most EB-5 applicants have elected to invest in existing, government- approved businesses called “Regional Centers.”1 For a number of reasons, the favored business structure for the Regional Center has been the limited partnership (LP). Use of the LP for Regional Centers has express sanction of the federal immigration authorities, provided the immigrant investors are sufficiently involved in the management of the business enterprise. Failure to become sufficiently involved in management could result in denial of the visa. However, corporate law governing business structures is state law, and most limited partnership acts proscribe managerial activity by limited partners. The sanction for noncompliance typically includes partial or total loss of limited liability. The Supreme Court recently addressed the applicability of the Supremacy Clause in Arizona v. United States,2 specifically in the context of an individual state’s attempt to address immigration issues within its borders. Equity interests in Regional Centers are usually offered by means of private placements. The standard disclosure document for private placements is the private placement memorandum or “PPM”. One section of the PPM is “Risk Factors,” which discusses various possible sources and areas of risk in the private placement. This paper examines whether a PPM for a Regional Center should include a risk factor that specifically addresses the tension between federal and state law regarding managerial activities of limited partners.
II. EB-5 Background
The EB-5 visa was created by Congress in 1990 as a vehicle for wealthy foreigners to obtain permanent residence by making a substantial investment in the U.S. The original provisions of the Immigration Act of 1990 set aside 10,000 visas per year for foreigners who invested between $500,000 and $3,000,000 in a new commercial enterprise that created at least ten full-time employment positions for U.S. citizens or lawful permanent residents of the U.S.3 In the following year, the implementing rule provided that the minimum investment amount should be $1,000,000, with the exception of investments in “high-unemployment areas” or “targeted employment areas” (“TEA’s”), which were defined as rural areas, or areas where unemployment rates were at least 150% of the national average. For these areas, the minimum investment amount was reduced to $500,000.4 In 1993 Congress adopted the “Immigrant Investor Pilot Program,” which provided, among other things, that the immigrant investor could invest in “Regional Centers,” funds that were defined by geography and scope of activity, and approved by the Immigration and Naturalization Service (the “INS,” later reorganized under the Department of Homeland Security as the U.S. Citizenship and Immigration Services, or “USCIS”).5 Investing in Regional Centers would have the obvious advantage of allowing investors to pool their resources and thereby undertake larger projects. Less obvious was the fact that it would relieve the immigrant investors of much of the responsibility of management of the enterprise. But perhaps most important was the provision that Regional Centers would be permitted to demonstrate that they had created ten jobs either directly or indirectly.6 Indirect job creation in this context means that the invested dollars have a multiplier effect as wages are paid, spent, taxed, and reinvested.7 For these reasons, TEA’s and regional centers have come to dominate the EB-5 landscape; at present, approximately 90% of EB-5 investments are in Regional Centers, nearly all of which are located in TEA’s.8 Thus, $500,000 in a Regional Center has come to be regarded as “market” for an EB-5 visa and green card.
III. Use of LP Structure for Regional Centers
The LP has become the vehicle of choice for many regional centers, particularly those that are involved in real estate development. There are a number of reasons for this, including pass-through tax treatment and the ability of the general partner both to maintain control and to receive profits that are disproportionate to its contribution of equity.9 (In the typical structure, the owner of the Regional Center acts a general partner, and the immigrant investors are the limited partners.) And there is one other reason: The regulations expressly permit it. Under federal law, a LP is a permissible corporate vehicle for a Regional Center, provided the immigrant investors are actively engaged in the management of the enterprise. As evidence of active engagement in management, a frequently cited provision reads as follows: If the new enterprise is a partnership, either limited or general, evidence that the petitioner is engaged in either direct management or policy making activities. For purposes of this section, if the petitioner is a limited partner and the limited partnership agreement provides the petitioner with certain rights, powers, and duties normally granted to limited partners under the Uniform Limited Partnership Act, the petitioner will be considered sufficiently engaged in the management of the new commercial enterprise.10 The Uniform Limited Partnership Act (ULPA) is one of several model acts drafted by the National Conference of Commissioners on Uniform State Laws (NCCUSL), perhaps the best known of which is the Uniform Commercial Code.11 While it is a well-known dictum among business lawyers that a limited partner should not become involved in the management of the partnership, and that failure to observe this could result in the loss of the limitation on liability, it is notable that this restriction does not appear in the applicable provision of the ULPA: A debt, obligation, or other liability of a limited partnership is not the debt, obligation, or other liability of a limited partner. A limited partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability of the partnership solely by reason of being or acting as a limited partner, even if the limited partner participates in the management and control of the limited partnership. This subsection applies regardless of the dissolution of the partnership.12 As of this writing, NCCUSL’s website shows that twenty-one states and the District of Columbia have enacted the ULPA.13 However, adoption of NCCUSL’s model acts is never done wholesale; various provisions are negotiated and revised, and therein lies the problem. For example, the corresponding provision of California’s Uniform Limited Partnership Act of 2008 provides as follows: A limited partner is not liable for any obligation of a limited partnership unless named as a general partner in the certificate or, in addition to exercising the rights and powers of a limited partner, the limited partner participates in the control of the business. If a limited partner participates in the control of the business without being named as a general partner, that partner may be held liable as a general partner only to persons who transact business with the limited partnership with actual knowledge of that partner’s participation in control and with a reasonable belief, based upon the limited partner’s conduct, that the partner is a general partner at the time of the transaction. Nothing in this chapter shall be construed to affect the liability of a limited partner to third parties for the limited partner’s participation in tortious conduct.14 The risk is clear: A limited partner of a LP that is operating in California could engage in management activities to an extent that would be entirely permissible under the ULPA, but would, under the California statute, risk at least partial forfeiture of the partner’s limitation on liability. Moreover, the risk is real. The USCIS lacks authority to pursue fraudulent investment schemes;15 its role is limited to granting and revoking Regional Center status.16 However, the Securities Exchange Commission has taken an increasingly active role in the EB-5 space.17 And while most of these schemes involve attempts to defraud hapless foreign investors, it is reasonable to assume that at least some of them also involve unsatisfied creditors. These are the potential plaintiffs in actions against the Regional Center and, where possible, its principals.
IV. Constitutional Frolic and Detour
Arizona. v. United States dealt with the constitutionality of a state statute18 that addressed the large number of unlawful aliens in the state of Arizona. The district court issued a preliminary injunction on enforcement of four of the statute’s provisions,19 which decision was affirmed on appeal to the Ninth Circuit.20 The Supreme Court granted certiorari. The enjoined provisions of the Arizona statute are as follows: §2(B), which required law enforcement officers conducting a stop, detention or arrest to make efforts in some circumstances, to verify the person’s immigration status with the Federal Government; §3, which made failure to comply with federal alien registration requirements a state misdemeanor; §5(C), which made it a misdemeanor for an unauthorized alien to seek or engage in work in the State; and §6, which authorized state and local law enforcement officers to arrest without a warrant any person “the officer has probable cause to believe … has committed any public offense that makes the person removable from the United States.” The Supreme Court’s analysis began with an acknowledgement of the Federal government’s broad power over immigration, as set forth in the Constitution21 and recognized in case law.22 The Court further cited the Supremacy Clause rule that federal law “shall be the supreme Law of the Land; and the Judges and every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the contrary notwithstanding.”23 In applying the principles of federalism and supremacy to the Arizona statute, the Court listed three instances where state law is preempted: 1. Where Congress enacts a statute containing an express preemption provision; 2. Where Congress, acting within its proper authority, has determined that the subject conduct must be regulated by its exclusive governance; and 3. Where state law conflicts with federal law. The Court further cited precedent that congressional intent, under (2), could be inferred where the framework of regulation is “so pervasive … that Congress left no room for the States to supplement it” or where there is a “federal interest … so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject.”24 In applying these three criteria, the Court upheld § 2(B) of the statute. It struck down §§ 3 and 5(C) under criteria (2), stating that federal law was so comprehensive as to preclude state regulation of these matters. It struck down § 6 under criteria (3), stating that enforcement of state law, as drafted, could frustrate and prevent full enforcement of federal law. Unfortunately, the three criteria of the Arizona case are of little help to us in reconciling EB-5 regulations with state limited-partnership acts. First, laws concerning the structure and governance of corporate entities are and always have been the near-exclusive domain of the states.25 Second, even when Congress has enacted as thorough a regulatory regime as securities regulation, it is left open the possibility of state regulation of the same activities. And third, even in the most restrictive state LP acts, there is no conflict between federal and state law. There is tension, to be sure, but nothing precludes full enforcement of both federal and state laws. Specifically, nothing in the California statute proscribes management activities by limited partners; it only prescribes that such activities may result in unlimited liability. By the same token, nothing in the EB-5 regulation mandates that limited partners will not incur unlimited liability; it only requires active management as a prerequisite to obtaining a visa.26 Two other points bear mentioning. First, a careful reading of the regulation reveals that it does not require management participation to the full extent set forth in the ULPA, but only gives that as an example of an acceptable level; perhaps something less would be sufficient. Second, the regulation does not mandate use of the LP structure; as discussed in the conclusion, other structures could suffice.
V. Disclosure to Investors
Federal securities laws and regulations, as well as the securities laws of many states, are based on the “blue sky” concept of disclosure, rather than value.27 For publicly traded securities, this disclosure takes the form of initial and ongoing public filings with the Securities Exchange Commission; private companies often employ a less rigorous form of disclosure known as a private placement memorandum, or PPM. The exemption from filing for a private placement is set forth in Section 4(a)(2) of the Securities Act. Most private placements are made pursuant to Rule 506 of Regulation D to this section, which is the safe harbor rule for private offerings.28 Rule 506 permits an unlimited amount of money to be raised from an unlimited number of accredited investors, plus up to thirty-five unaccredited investors. Some Regional Centers rely on Regulation S, the exemption for offshore offerings, on the theory that EB-5 offerings are by definition made to persons outside the U.S. However, the better practice is to rely on Regulation D, or on both Regulations D and S. Use of a PPM is voluntary if all investors are both accredited and sophisticated, and given an opportunity to make inquiries about the offering. However, use of a PPM is highly advisable, if only to estop the investor from claiming reliance on information outside of its four corners. The structure of a PPM is set forth in Regulation S-K.29 For our purposes, the most significant part of the document is the discussion of “Risk Factors,” which are required under a concept with the ungainly name of the “Bespeaks Caution Doctrine.”30 These are described as follows: Risk factors. Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make the offering speculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply to any issuer or any offering. Explain how the risk affects the issuer or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk. The risk factor discussion must immediately follow the summary section. If you do not include a summary section, the risk factor section must immediately follow the cover page of the prospectus or the pricing information section that immediately follows the cover page. Pricing information means price and price-related information that you may omit from the prospectus in an effective registration statement based on §230.430A(a) of this chapter. The risk factors may include, among other things, the following: 1. Your lack of an operating history; 2. Your lack of profitable operations in recent periods; 3. Your financial position; 4. Your business or proposed business; or 5. The lack of a market for your common equity securities or securities convertible into or exercisable for common equity securities.31 By way of example, a risk factor addressing a lack of an operating history might read as follows: The Company Has No Operating History The Company was established on [DATE]. It remains a development stage business with limited operating history. There can be no assurance that the Company will be successful in building its business or that its business model will prove to be successful. Risk factors that commonly appear in Regional Center PPMs include the following: “Your investment does not guarantee that you will obtain U.S. residency.” “Achievement of your immigration goals depends on the regional center’s maintaining good standing with USCIS.” “The EB-5 Regional Center Program will expire unless Congress renews it.” “Proposed EB-5 legislation could change the requirements for EB-5 investments.” “If your country is subject to travel restrictions you may not be able to obtain a visa.” “EB-5 petitions are subject to delays.” “The project may not generate enough jobs for all investors to obtain permanent, unconditional U.S. residency.” “In the event of a shortfall, the USCIS may not approve our method of allocating jobs to investors.” “Investors may not have a sufficient role in management.” “The USCIS may stop issuing new EB-5 visas if it reaches the annual limit.”32
VI. Should Regional Center PPMS Include a Risk Factor Discussing Federal-State Tension?
One of the most frequently asked questions among EB-5 investors is: What is the most that I can lose from this investment? The standard response is: In a limited partnership, a limited partner’s exposure does not extend beyond the amount of the investment. However, as noted above, there is a tension between the federal immigration law requirement that immigrant investors be involved in the management of the business enterprise and state corporate law prohibitions on limited partners becoming involved in the management of limited partnerships. The hapless immigrant investor, very likely new to the whole concept of investing in American businesses, is forced to navigate between the Scylla of loss of the conditional green card (which is the reason for making the investment), and the Charybdis of general liability for the debts of the Regional Center. An LP who exercises too much restraint runs the risk of failing to satisfy an essential requirement of the visa application, and forfeiting the conditional green card. But an LP who becomes too actively involved in management of the enterprise risks loss of the protection of limited liability. The risk of not obtaining a visa is typically covered in detail in a Regional Center PPM. Therefore, a Risk Factor that addresses this more specific risk might read as follows: Involvement in Management Could Result in Unlimited Liability The Company is structured as a Limited Partnership. While the USCIS requires that EB-5 investors be actively involved in the management of the business, California’s corporate laws discourage this. Under California’s laws, a limited partner who becomes excessively involved in management of the business could become fully liable for the debts of the Company. It is difficult to argue that this is not among “the most significant factors that make the offering speculative or risky.” Therefore, issuers and their securities counsel who fail to warn investors of this risk may be remiss in their obligations under Regulation S-K.
At this point, it is fair to ask: If this is such a serious problem, why has no one noticed it before? Perhaps one answer is specialization; immigration lawyers may be unfamiliar with corporate law. At least as it applies to LPs, federal regulations drafters may not have realized that a slight change in a state’s partnership act could produce such markedly different results than under the ULPA, and Regional Center owners, many of them seasoned real estate developers, could be forgiven for assuming that foreign investors would be the least likely of LP candidates to seek an active role in management. But where were the corporate and securities lawyers? In the future, lawyers who draft PPMs for Regional Centers would be well advised to consider including a Risk Factor such as the sample in the preceding section. And there is another possible solution. Nothing in the CFR provision cited above dictates the use of the LP structure for Regional Centers; an alternate form of acceptable evidence is “that the petitioner is a corporate officer or a member of the corporate board of directors, for a corporation.33 And although the regulation does not specifically mention limited liability companies, the list is not exclusive in nature. It is reasonable to assume that an LLC member granted more than a passive investor’s role could satisfy the “actively engaged in management” requirement, especially in light of the increasingly common use of LLCs in real estate projects. * The author is a partner in the Los Angeles office of Wilson, Elser, Moskowitz, Edelman & Dicker, where he practices corporate and securities law.
1. This is actually a bit of a misnomer. Immigrant investors typically do not invest in the Regional Center itself. The Regional Center is an entity, typically a corporation or limited liability company, that has been approved by the USCIS for management of EB-5 investments. In a now frequently used pattern, the Regional Center sets up a fund for the foreign investors (the new commercial enterprise, or NCE), which then makes either an equity or debt investment in the actual project entity (the job creating entity, or JCE). See, e.g., http:// www.eb5investors.com/eb5-basics/eb-5-regional- center for a discussion of this structure. The NCE is often structured as a limited partnership, with the immigrant investors acquiring limited partnership interests. In such cases, the “Regional Center PPM,” as the term is used in this article, would be for the NCE, and could include risks in the NCE’s investment in the JCE. 2. 567 U.S. 387, (2012). 3. See, e.g., David Hirson & Catherine I. Mayou, 10(1) Immigrant Investor Visas – An Update, CAL INT’L PRACT. (2000). 4. 8 C.F.R. § 204.6. 5. A serviceable description of the EB-5 visa and its history can be found at William Tolin Gay, Immigrant Investor Visas and Diversification: An Application of Modern Portfolio Theory to EB-5 Regional Centers, CAL INT’L LAW J., vol. 22, no. 1 Spring/Summer2014, at 15 et seq. 6. 8 C.F.R. § 204.6(m)(7). 7. Bivens, Josh, Updated Employment Multipliers for the U.S. Economy (2003), Economic Policy Inst., Aug. 2003, no. 268:3. 8. As of March 6, 2017, there are 880 approved Regional Centers in the U.S. https:// www.uscis.gov/working-united-states/ permanent-workers/employment-based-immigration-fifth-preference-eb-5/immigrant- investor-regional-centers. 9. A typical “waterfall” of income and capital gains in a real estate development LP might be structured as follows: (a) first distributable income, after payment of all current obligations, is a preferred dividend of 5% to limited partner(s); (b) any remaining distributable income divided 60/40 between general partner(s) and limited partner(s); and (c) upon liquidation or sale of the project, limited partner(s) receive their initial investment plus 8%, and excess proceeds are divided 60/40 between general partner(s) and limited partner(s). As can be seen from this example, in a successful project, general partners can do quite well with little or no financial outlay. 10. 8 C.F.R. § 204.6(j)(4)(iii). 11. NCCUSL’s website can be found at http:// uniformlaws.org/Default.aspx. 12. Uniform Limited Partnership Act of 2008, § 303(a). 13. http://uniformlaws.org/Act.aspx. 14. Uniform Limited Partnership Act of 2008, § 15903.03(a). 15. U.S. Dep’t of Homeland Security, Office of Inspector Gen’l, OIG-14-19, United States Citizenship and Immigration Services’ Employment- Based Fifth Preference (EB-5) Regional Center Program. 16. For a current list of terminated Regional Centers, see https://www.uscis.gov/working- united-states/permanent-workers/employment- based-immigration-fifth-preference-eb-5/ eb-5-immigrant-investor-process/regional-center- terminations, for a current list of terminated Regional Centers. 17. A broad general warning to investors can be found at Investor Alert: Investment Scams Exploit Immigrant Investor Program, https://www. sec.gov/oiea/investor-alerts-bulletins/investor- alerts-ia_immigranthtm.html. A search of “EB-5” at the SEC website produces a long list of actions by the Commission. Most of these involve scams where the investors’ money, or a significant part of it, was diverted to the personal benefit of the Regional Center owners. Others involve brokerage commissions paid to unlicensed persons, including, in some cases, immigration attorneys. 18. S.B. 1070, popularly known as “Support Our Law Enforcement and Safe Neighborhoods Act.” 19. 703 F. Supp. 2d 980, 1008 (2010). 20. 641 F. 3d 339, 366 (2011). 21. U.S. CONST., art. I, § 8, cl. 4. 22. Toll v. Moreno, 458 U.S. 1, 10 (1982). 23. U.S. CONST., Art. VI, cl. 2. 24. Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947). 25. Limited exceptions exist, such as regulatory and disclosure requirements under the Securities Act and Securities Exchange Act, but these are generally in the realm of shareholder protection in the purchase and sale of securities. 26. For that reason, this federal regulation is not a “safe harbor” from state laws, as has been suggested by some commentators. 27. https://www.sec.gov/fast-answers/answers- blueskyhtm.html.