The SEC has not always prevailed in court on its more aggressive territorial view or on its narrow focus on transaction-based compensation as a sole trigger for broker-dealer registration . Engaging in the common practices of EB-5 fundraising nonetheless raises a number of risks , even if the SEC could not ultimately prevail in court .
One large regional center group , CanAm Enterprises , believed that the SEC ’ s focus and concern warranted the establishment of an affiliated broker-dealer entity .
Recent SEC Enforcement Activity
As of the date of this writing , the SEC has not publicly announced any enforcement actions directly related to broker-dealer activity in EB-5 offerings . However , we are aware that certain participants in EB-5 transactions have been issued subpoenas from the SEC Division of Enforcement requesting information about their fundraising activities , including parties to whom such participants paid commissions .
SEC enforcement activities outside the EB-5 industry indicate an increasing enforcement focus by the SEC on broker-dealer activity .
For example , in March 2013 , Ranieri Partners , an unlicensed “ finder ” hired by Ranieri Partners , and the individual at Ranieri Partners who supervised such finder , settled charges brought by the SEC that they violated the Exchange Act in connection with the finder ’ s activities . Those activities included transmitting important financial document to the investors such as private placement memoranda , subscription documents , due diligence materials and his personal analysis of the investment .
In late 2012 , Neogenix Oncology , a publicly-traded company , filed for bankruptcy and reorganized after the SEC inquired about fees paid to unlicensed finders in connection with private placements conducted by the company . The SEC questioned whether the company should have reserved in its financial statements for liabilities from potential demands by investors for refunds of their investments on the basis of the involvement of unlicensed finders . Unable to continue to raise funds as result of the uncertainties from the SEC inquiries , the company filed for bankruptcy and reorganized into a new company .
Consequences of Use of Unlicensed Broker-Dealers
The involvement of a person required to be registered as a broker-dealer , but who is not so registered , creates a number of risks to the unregistered party , to the issuer of the securities and its principals , and to the EB-5 investors .
One risk is the possibility of SEC enforcement actions , state regulator enforcement actions and criminal charges brought by U . S . or state prosecutors . Even if the government does not prevail in such actions , the legal costs of defending such actions can be enormous .
A separate concern is the risk that investors may be able to demand return of their investments , known as a rescission right , due to the involvement of unlicensed broker-dealers . It is not
clear the extent to which investors have this right under U . S . or state laws , or , if they do have this right , whether they have the right against the unlicensed finder , the issuer of the security or both . However , as illustrated in the Neogenix matter discussed above , the mere threat of rescission rights can create substantial problems for an issuer of securities . For example , if it becomes clear at some point that an EB-5 project will not return money to the investors in the timeframe they expect , those investors , or contingency fee plaintiffs ’ attorneys could bring claims against persons deemed responsible for the alleged broker-dealer violation , including parent companies of the project and the individual project executives who promoted the project and supervised the unlicensed individuals . Regardless of merit , these claims may be expensive to defend and the defendant may determine that it is cheaper to settle the action than to pay the costs of defense .
Apart from the costs , government or private-party litigation can cause significant reputational damage and discourage investors from participating in current or future offerings .
Alternatives for Joining the Broker-Dealer Regulatory Framework
There are a number of options for involving a licensed broker-dealer , and therefore removing the risk associated with paying commissions and other transaction-based compensation to unlicensed persons .
1 . Register as a broker-dealer : This alternative requires the creation of an affiliated entity to register with the SEC and each state in which it conducts business , join FINRA , employ individuals with the requisite securities licenses and meet substantial ongoing regulatory , oversight and capital requirements . Each individual who obtains a license must submit detailed information about his / her employment history , criminal background , qualifications , disciplinary issues and any litigation or arbitration actions , as well as study for and take exams . As noted above , this was the alternative chosen by CanAm Enterprises . Smaller regional centers and project sponsors may find this alternative unattractive due to the substantial initial costs and ongoing compliance costs .
2 . Purchase a broker-dealer : Purchasing an existing broker-dealer may provide the benefits of licensing quicker than registering from scratch . Also , the buyer may be able to take advantage of the brokerdealer ’ s existing regulatory infrastructure . But for many in the EB-5 community , this alternative may be unattractive for the same cost reasons as stated above .
3 . Affiliate with a broker-dealer : Individuals who obtain appropriate licenses from FINRA as a registered representative may affiliate with a registered broker-dealer firm and receive transaction-based compensation through the registered broker-dealer .
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