EB5 Investors Magazine | Page 26

Continued from page 23 Covered Persons Covered persons under 506(d) generally fall into four broad categories: • The issuer itself • Individuals who control the issuer, for example, the principals of a regional center or developer that will be general partner or manager of an EB-5 fund • Beneficial owners - individuals or companies that control 20 percent or more of the issuer’s voting securities • Individuals and companies associated with the offering, including company officers, fund managers and “promoters.” The Bad Acts The bad acts specified under Rule 506(b) generally fall into the following categories: • Convictions for crimes – either felonies or misdemeanors – involving securities • Court orders or decrees that bar the covered person from specific activities involving securities • Orders of state and federal banking, insurance and commodities regulators • SEC orders that prohibit a covered person from engaging in specified business activities or order a person to stop committing fraud or illegal offerings • Expulsion from membership in a securities exchange or a national securities association for failing to follow just and equitable principles of trade • Making or underwriting a registered offering that was stopped or suspended by the SEC, or is currently the subject of investigations or proceedings for a stop order or suspension • Orders of the U.S. Postal Service related to false representations (i.e., mail fraud). The Rule has varying “look back” periods for the bad acts. Generally, a bad act disqualifies the covered person or must be disclosed (if the act falls within the grandfathering period) if it occurred within five years of the contemplated Rule 506 offering. However, criminal convictions for covered persons other than the issuer have a look-back period of 10 years. Orders that bar the covered person from business activities or enjoin the covered person from committing wrongful acts will be disqualifying bad acts if the bar or injunction is effective at the time of the contemplated Rule 506 offering. 24 “…Rule 506(d) stands for the proposition that even wealthy and sophisticated investors are entitled to an assumption that persons legally offering them securities are not convicted felons or persons who have been cast out of the more regulated sectors of the financial community for their misdeeds.” Phased Due Diligence Review Companies planning an EB-5 offering should begin the due diligence process early, and for regional centers and developers that regularly raise EB-5 funds, bad actor due diligence should be an ongoing process, integrated into the general background checks performed when engaging team members and strategic partners for projects. This article lays out a phased approach to Rule 506(d) due diligence – it is just one manner by which bad actor checks might be accomplished. Rather than leaping to the minute criteria of the Rule, one could begin with broad categories of potential bad acts. While this approach will result in “false positives” – people who have committed misdeeds that don’t ultimately disqualify them –it should rule out bad acts for the vast majority of covered persons, eliminating the need to investigate further. When a potential problem is found, the investigator can more closely examine the conduct and determine if it falls within the bad acts. Identification of Covered Persons. The first step in any inquiry will be to identify the covered persons. Managers, general partners, directors and executive officers, officers preparing offering materials or communicating with investors, financial advisors and brokers are all easily identified and classified as covered persons. The issuer should work with securities counsel to determine if covered persons exist in any of the Rule’s more technically defined categories. Phase One Review. A phase one review would generally include a questionnaire with checklist of bad acts and room for explanation. Because it is not reasonable to assume that bad actors always tell the truth, questionnaires are not sufficient. However, they can flag problems for both the covered person and the issuer that warrant a deeper analysis. A brief questionnaire with a few broad questions, rather than simply cutting and pasting the entire text of Rule 506(d) and adding checkboxes, would be the goal during phase one. For example, “Have you ever been the subject of an order issued by any state or federal agen