FINRA Weighs In On EB-5 Due Diligence

The Financial Industry Regulatory Authority, which regulates the conduct of broker-dealers and their representatives, has replied to a member’s request for interpretive guidance on the applicability of FINRA Rule 2111 to EB-5 Program securities transactions.  The request for guidance came from FINRA member and broker-dealer, Trustmont Financial Inc., which earlier this year had decided to partner with a previously unlicensed EB-5 due diligence firm in Florida that was also involved in EB-5 project consultation and ownership.  Trustmont sought to avoid the standard suitability requirements established by FINRA over the years, which is summarized in FINRA’s Rule 2111 and in Regulatory Notice 10-22 (April 2010)[1].  This burden on broker-dealers is substantial, and requires that broker-dealers must initially “perform reasonable diligence to understand the nature of a recommended security or investment strategy involving a security, including its potential risks and rewards, and then determine whether there is a reasonable basis to believe the recommended security or investment strategy is suitable for at least some investors”[2], and, further, with regard to each individual investor, the broker-dealer “must have a reasonable basis to believe that a recommended security or investment strategy involving a security is suitable for a particular customer based on the customer’s investment profile.”[3]


Trustmont made a novel argument – that the normal suitability requirements imposed on broker-dealers should not apply to EB-5 offerings because “the purpose of an EB-5 project is primarily the creation of jobs, secondarily to provide an alien investor with a right of residence in the United States, and only [thirdly] to achieve investment performance[.]” Trustmont further argued, somewhat apocalyptically, that, “[i]f the jobs and visa motivations are wholly discounted or excluded in suitability determinations, Rule 2111 has the capacity to halt all investment in EB-5 projects, as broker-dealers cannot satisfy the substantial and demanding requirements of Rule 2111 in the sale of an EB-5 investment.”


FINRA disagreed, stating unequivocally that EB-5 offerings fall squarely within FINRA suitability rules, noting that “EB-5 Program securities transactions that involve pooled investments sold through private placements raise many of the same concerns as those associated with sales of any private-placement securities” and citing as further support the SEC’s recent action against the Chicago Convention Center. The letter further asserts that “[t]he safeguards provided by the suitability rule are no less important where the FINRA member’s customers are foreign nationals seeking investment returns and a path to U.S. residency.”


There was nothing jarring or new here. The FINRA Rules by the nature of the industry they seek to regulate have always incorporated sufficient flexibility to adapt to new areas of investment. What did surprise some, however, was the assertion that financial analysis of an EB-5 project was not sufficient by itself, but that, in addition, the “a broker-dealer also should analyze whether the private placement is consistent with the requirements of the EB-5 Program, such as whether it constitutes an investment in a domestic project that will create or preserve at least 10 jobs for U.S. workers” and, further, the broker-dealer “should evaluate the investment in the context of the customer’s goal of obtaining U.S. residency through purchasing an investment that is consistent with the requirements of the EB-5 Program.”

FINRA now requires that its members understand the immigration law aspects of the investment and weigh them in the due diligence analysis just like any other customer-specific factor present in the investor’s profile such as “age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, and risk tolerance.”

FINRA’s assertion that financial analysis is not sufficient when evaluating and EB-5 offering, but that an understanding of the complex immigration law and economics questions is also vital, including the very technical mixed law/economics questions raised by assessing job creation prospects.  Further complicating the picture is the fact that issues of law, economics and finance overlap and interact in EB 5 project evaluation in such a way as to make it almost impossible to speak of mere “financial due diligence “or “job creation due diligence” or “legal due diligence”. Knowledge of all three disciplines – immigration law, economics, finance, and implicitly also securities law compliance – is required to make a reasonable prediction of success in obtaining lawful permanent resident status as well as success in obtaining return of principal.

The practical implications of FINRA’s guidance is that any member evaluating EB-5 investments for customers must either develop the required expertise in EB-5 law, state their opinions subject to a disclaimer (which may, in fact, not be possible under current FINRA rules), or work in close cooperation with an experienced immigration attorney. It’s not likely that splitting the job into a legal and a financial analysis without any exchange between the analysts will do either.

Given the SEC action against the Chicago Convention Center project earlier this year, and now the guidance from FINRA, it looks like the EB-5 world is increasingly being incorporated to the rest of the financial community with all its rules, oversight, and penalties for misbehavior. However, there are still worrisome holdouts from the wilder earlier days of the latter day EB-5 renaissance. These actors, and they are only a few, persist in activity that has been almost universally condemned as securities violations because the money’s simply too good. Whether such actors will wake up and hear the police sirens down the road remains to be seen.

by John Roth

[1] FINRA stated that, when recommending a privately-placed security, a broker-dealer “should, at a minimum, conduct a reasonable investigation concerning the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering.” The required inquiry is far more extensive, in fact..

[2] See FINRA Rule 2111.05(a)

[3] See FINRA Rules 2111(a); 2111.05(b).

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