One of the most important responsibilities of every general partner or manager of a new commercial enterprise (“NCE”) will be the choice of investment alternative for the NCE’s capital upon redeployment from its initial investment in a job creating entity (“JCE”). In its revised Policy Manual released June 14, 2017, USCIS issued new guidance that requires redeployment of an NCE’s EB-5 investment capital if the JCE returns the NCE’s capital investment before all of the EB-5 investors in the NCE have completed their two year conditional permanent residency period. The biggest impact of this redeployment requirement is on EB-5 investors from mainland China, because of the current waiting time to process their conditional residency visas, which according to the USCIS Ombudsman 2017 Annual Report will result in delays of 10 to12 years in the completion of the conditional permanent residency period for these investors. This will necessitate a redeployment of capital by the NCE for potentially five to seven years after the original investment in the JCE has been returned to the NCE.
This USCIS-imposed redeployment requirement creates new risks and responsibilities for the general partner or manager of the NCE, who are charged with the fiduciary responsibility of managing the NCE for the benefit of its EB-5 investors. Most NCEs do not provide for an automatic approved form of reinvestment upon repayment by the JCE, particularly those NCEs formed prior to 2015, when the “retrogression” of EB-5 visas occurred for the first time for investors from mainland China. Therefore, the general partner or manager of the NCE bears the responsibility for selecting or recommending an alternative investment of the NCE’s capital during the required redeployment period. Even if the general partner or manager allows the EB-5 investors to approve the alternative investment, those investors will be relying upon the general partner or manager to recommend one or more reinvestment alternatives that are appropriate for the EB-5 investors.
How will the general partner or manager of the NCE demonstrate that it has met its fiduciary duties to the EB-5 investors in the selection of a reinvestment alternative for the NCE? One of the most valuable ways of meeting this responsibility is to engage an independent registered investment adviser to review and advise the NCE on the available reinvestment alternatives. Here are ways in which the registered investment adviser (“RIA”) can protect the general partner or manager of the NCE, as well as the EB-5 investors, in connection with the reinvestment of the NCE’s capital:
- The RIA can provide independent advice when the general partner or manager has conflicts of interest in the choice of reinvestment alternatives.
If the NCE does not already have a specifically designated reinvestment that was disclosed to the EB-5 investors at the time of their original investment, the general partner or manager of the NCE will often have conflicts of interest in selecting the reinvestment option for the NCE. Conflicts of interest usually arise when the reinvestment is in a project in which the general partner or manager or one of its affiliates has a financial interest, or a project in which the original developer has a financial interest which may result in a financial benefit to the general partner or manager, or an investment that pays a higher rate of return to the general partner or manager, but results in a higher risk of loss of capital to the EB-5 investors. Similar conflicts of interest may have existed with the original investment in the JCE, but the EB-5 investors were likely informed of those conflicts of interest in the offering documents when they made their original investment, whereas the EB-5 investors may not be provided with a choice of another reinvestment option at the time the general partner or manager selects a reinvestment. The EB-5 investors therefore have little if any ability to protect their own interests when the reinvestment is made by the NCE. In that situation, if anything goes wrong with the reinvestment, the EB-5 investors will potentially have a good claim against the general partner or manager for making a reinvestment that violated their fiduciary duties to the EB-5 investors. However, if the general partner or manager obtains advice from an independent RIA in selecting the reinvestment, the independent RIA can review the reinvestment from the perspective of the EB-5 investors, to determine that their interests are adequately protected.
- An RIA can provide expert due diligence on one or more reinvestment options.
All reinvestment options considered by the general partner or manager of an NCE must be thoroughly reviewed and analyzed, to the same extent as the original investment by the NCE. If one of the reinvestment options being considered is an investment in another single asset project, all of the elements of the investment must be examined, including details regarding the property, the project, the background of the developer, the financing for the project and the anticipated exit strategy. Although due diligence on a real estate project could be done by a real estate expert, having an RIA conduct or review the analysis is particularly important where more than one reinvestment option is being considered, because the RIA can compare the relative advantages and disadvantages of each reinvestment option.
- An RIA can provide access to multiple reinvestment alternatives before a reinvestment option is selected.
One of the functions of an RIA is to analyze multiple investment alternatives, compare their relative advantages and disadvantages, and determine which of them is most appropriate for each NCE. This will depend upon numerous factors, including the type of investments the NCE is authorized to make in its partnership agreement or operating agreement, the liquidity needs of the NCE, the risk level that is appropriate for the NCE, among others. The independent RIA may also have the ability to introduce investment options that are not otherwise available or known to the general partner or manager of the NCE. In addition, the independent RIA may have already conducted due diligence on one or more of these available investment options, which will assist the general partner or manager to determine which option will best suit the requirements of the NCE. An independent RIA that is knowledgeable regarding the requirements of the EB-5 requirements will be able to analyze both the immigration-related factors and financial and risk-related factors that should be considered in making the reinvestment decision.
- An RIA can protect against claims that the general partner or manager is acting as an unregistered investment adviser in making a reinvestment decision.
The Investment Advisers Act of 1940 requires that general partners or managers of private investment funds be registered as investment advisers under certain circumstances (which will not be detailed in this article). The securities laws of the states also have registration requirements that may apply to general partners or managers of private investment funds. There are no precedent decisions or policies that specifically address the issue of whether a general partner or manager of an NCE is required to register as an investment adviser. A good argument can be made that they should not be required to register as an investment adviser with respect to the initial investment made by an NCE, since the NCE was established primarily for the purpose of making one investment in the JCE, and that investment is fully disclosed to all investors at the time they make their decision to invest in the NCE. However, when a reinvestment is required to be made by the NCE, unless that reinvestment was also fully disclosed to the EB-5 investors at the time of their investment decision, the general partner or manager will be required to analyze multiple investment options and select or recommend an investment. That creates a potential argument that the general partner or manager should not make a reinvestment decision on behalf of the NCE unless it is itself a registered investment adviser, depending upon the federal or state law that applies to each general partner or manager. One possible way of mitigating this risk is for the general partner or manager to engage an independent RIA to analyze and determine the most appropriate reinvestment option for the NCE.
- An RIA can be part of a securities compliance program adopted by the general partner or manager of an NCE.
There have been several legislative proposals introduced to reform the EB-5 program that would include certification requirements for regional centers, including certification of securities law compliance. Although we do not know whether any of those legislative proposals will be adopted, we do know that a securities compliance program can be helpful in following best practices and in establishing a defense against potential claims by disgruntled investors for any reason, or investigations by government agencies. Engaging an RIA to assist in the analysis and selection of a reinvestment option for an NCE can be an important part of such a compliance program, because it demonstrates the efforts of the general partner or manager of the NCE to protect the EB-5 investors and comply with applicable securities laws.
Conclusion: Engagement of an independent RIA in connection with a reinvestment of NCE capital can protect general partners and managers of NCEs, as well as EB-5 investors, by providing independent advice, access to multiple investment options, and securities law compliance.