Now that the USCIS has provided clarity about the redeployment of EB-5 capital at the NCE level, the real issue surrounding redeployment is the investment products selected.
The two primary issues surrounding NCE redeployment are 1) compliance issues associated with investing, and 2) fiduciary duties related to selecting new investments.
Compliance Issues Associated with Redeployment Investing
NCEs offer their investments to EB-5 foreign investors via SEC Regulation D & Regulation S offerings. Reg. D and Reg. S offerings are advantageous because funding is faster, and these types of offerings are generally exempt from SEC registration.
The NCE’s PPM is typically very narrow in scope, often stating that it is merely making a loan to the JCE’s job-creating investment opportunity. However, redeployment is often broad in scope, where the NCE and Regional Centers will consider a full range of investments, which may include real estate developments, asset-backed loans, government bonds, or publicly traded securities.
These choices trigger a host of compliance concerns. Namely, that that the Investment Advisers Act & Investment Company Act must be considered when pursuing redeployment of investor capital.
Investment Advisers Act
This Act, passed in 1940, defines the role and responsibilities of investment advisers. The law provides the legal groundwork for monitoring those who advise pension funds, individuals, and institutions on investing. It also specifies what constitutes investment advice and stipulates who must register with state and federal regulators in order to offer advice to investors.
A commonly overlooked issue is that many Regional Centers believe that merely by investing in additional real estate investments, such as real estate developments or secured real estate loans, they will avoid this regulation. Ignoring this law could be detrimental and cause regulatory issues, since these asset classes are almost always considered securities, albeit exempt.
Although they may be considered exempt, it is essential to note that exempt advisers are NOT exempt from compliance. They must still file a limited Form ADV and also conform to specific qualifications to maintain the exemption.
Investment Company Act
Passed in 1940, this law regulates the organization of investment companies and activities with which they engage. The Act also sets the standards for the industry and clearly defines the responsibilities and requirements of investment companies and the offerings they present to prospective investors. It primarily targets publically traded retail investment products.
ssed in 1940, this law regulates the organization of investment companies and activities with which they engage. The Act also sets the standards for the industry and clearly defines the responsibilities and requirements of investment companies and the offerings they present to prospective investors. It primarily targets publically traded retail investment products.
While most Regional Centers and NCEs are aware of Sec. 3(c)(1) and Sec. 3(c)(5), which provides private funds and exemption from requirements of the SEC, they may fail to realize that many states do not recognize 3(c)(5) as an exemption to reporting as an adviser. If an NCE is comprised of more than 100 investors, the NCE’s GP may not be eligible for exemption under the Investment Advisers Act based on that particular state’s regulatory scheme.
Local Compliance Concerns
One significant, and largely overlooked, area of concern during redeployment is the myriad of local compliance issues which may be in place. One popular asset class for investment is secured real estate loans or private loan pools. Outside of federal securities compliance, many NCE, GPs, and Regional Centers believe they can simply invest in these products without consideration of local rules and regulations.
For example, it is not commonly known that California, Nevada, and Arizona all require a license to make loans secured by real estate, regardless if it is a commercial or residential property. Furthermore, several states require a license to purchase loans as well. Therefore, NCEs, GPs, and Regional Centers should exercise great care when considering investment into local communities, and ensure they are familiar with local regulations to avoid costly and unnecessary compliance headaches.
Fiduciary Duty & Conflict of Interest
A common theme in the EB-5 industry is the NCE, GP, and Regional Center’s plan to redeploy investor capital into additional projects managed by the GP, the Regional Center, or affiliate entities. While this is often technically legal, it may present a conflict of interest and may not fully meet the GP/Regional Center’s duty of loyalty to the investor.
The issue at hand is that some investments may not be aligned with the best interest of the investors. Some EB-5 investors may have expectations that differ from that being presented by the Regional Center.
Investor Expectations
The EB-5 program is known for a meager rate of return to the actual investors. The primary benefit for the investor is residency, and while most are comfortable with that result, it would be unfair to subject them to minimized returns, especially since they are responsible for the JCE completing its project.
In placing the investors’ interests first financially, it increases the likelihood of investor buy-in, reduces the risk of combative investors, and creates aligned interests between the NCE, GP/Regional Center, and the investors.
Liquidity is also a significant concern, since many real estate investments require loan-term holds, typically over 1-3 years. Furthermore, if the investment is an equity position, it may not produce returns until there is a crystallizing event, such as a sale or transfer of the property. In the alternative, some GPs have suggested redeploying as another construction or mezzanine loan similar to the original EB-5 investment, which is a more nuanced issue typically associated with increased risk.
Although all investments are subject to risk, EB-5 investors have an expectation of receiving their capital investment back. While the investor must accept that risk in the initial investment, it may not be wise or ethical for the GP/Regional Center to select that same risk profile for the investors in redeployment.
Conclusion
In summary, we believe that EB-5 NCE, GPs, and Regional Centers should consider selecting redeployment investments which are investor-focused, provide a better economic return than the original investment, and have enough liquidity to offer flexibility so that the investors are not forced to wait beyond the adjudication period that USCIS imposes.
One solution is for the NCEs to consider investing in senior secured real estate loans or pools. These types of assets are in 1st position, offer an attractive rate of return (approx. 6-9% per annum), and carry a variety of maturity dates to select from, which provides greater flexibility for the investors’ application process, along with the liquidity they desire.
