Sec Confirms Its Authority in Eb-5 and Tags Immigration Attorney for Unregistered Brokering in California Federal Court Win: Sec v. Feng

• Publication year: 2018
• Author: Charles S. Kaufman*

SEC CONFIRMS ITS AUTHORITY IN EB-5 AND TAGS IMMIGRATION ATTORNEY FOR UNREGISTERED BROKERING IN CALIFORNIA FEDERAL COURT WIN: SEC V. FENG

Charles S. Kaufman*

A U.S. District Court decision in California has strengthened the legal foundation for the Securities and Exchange Commission (SEC) in its initiative to enforce federal securities laws in the marketing of investment opportunities under the EB-5 immigrant investor visa program, and underscored the risk of ignoring those laws. In the closely watched case SEC v. Feng,¹ the court issued two noteworthy holdings:

• EB-5 investments are "securities" under the federal securities laws and subject to regulation under those laws.
• An attorney who acts as a broker for a client's investment in an EB-5 investment opportunity must register with the SEC as a broker-dealer.

In reaching its conclusions the Feng court also affirmed, in the EB-5 context, that information about the payment of referral fees or commissions to intermediaries is material to investors as a matter of law, and that an immigration attorney who participates in an offering and omits disclosure of his receipt of commissions is liable under the anti-fraud provisions of the securities laws.² Issuers and others who omit this information "in connection with the offer or sale of a security" would face similar statutory liability.

The defendants, Hui Feng and his law firm, are immigration attorneys based in Flushing, New York. Over several years Mr. Feng and the firm recommended EB-5 investment opportunities to clients seeking U.S. residency. Mr. Feng and the firm collected sales commissions and referral fees from the promoters of these offerings, often through offshore agents that appeared unrelated to Mr. Feng but that he owned and controlled. Approximately 100 clients purchased EB-5 investments from approximately five regional center sponsors through these recommendations. The majority of Mr. Feng's clients did not know that he or his affiliates received commissions on the clients' investments.³

The court determined that it had received sufficient uncontested evidence to rule for the SEC by summary judgment on all points of the agency's civil enforcement suit—that is, without the need for a trial. The court found Feng liable for uregistered broker-dealer activity and for violating the anti-fraud statutes of both major federal securities laws by concealing his referral fees from clients and from regional centers sponsoring projects that offered the investments. The ruling requires Feng and his firm to disgorge approximately $1.8 million in unlawful commissions (including interest), pay nearly $1 million in civil penalties and permanently enjoins them from further violations of the federal securities laws.

The EB-5 Immigrant Investor Program was created by Congress in 1992 to encourage foreign investment in U.S. job-creating activities. Investors who invest $500,000 or $1,000,000 (depending on location) in an eligible project may apply to the United States Citizenship and Immigration Services (USCIS) to receive conditional U.S. residency for themselves and their immediate family. If the project successfully creates 10 jobs for each investor, the investors may apply to USCIS to remove their conditions to residency and receive permanent, unconditional residency. "Regional centers" are entities authorized by USCIS to sponsor and promote EB-5 investments in projects within a specified territory. Most, but not all, EB-5 projects affiliate with an authorized regional center because regional center sponsored projects can prove job creation based on economic modeling rather than strictly based on payroll.

The Feng case is one of several similar civil enforcement actions involving EB-5 investments that the SEC initiated in 2015. Other than Feng and his firm, all defendants in those actions settled with the SEC prior to any court proceedings.⁴ Feng has argued that under the well-established "Howey test,"⁵ EB-5

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investments are not "securities" within the definition of the federal securities laws because the investors seek immigration benefits rather than profit. He has argued that the SEC's enforcement actions against immigration attorneys for unregistered broker-dealer activities in EB-5 offerings represent the agency's unwarranted over-reach beyond its jurisdiction to interfere in the attorney-client relationship.⁶

Feng characterized the issue of whether EB-5 investments are securities as an "issue of first impression," that is, a novel issue for the court, for which no binding legal precedent exists.⁷ However, the court did not treat the question as an issue of first impression and cited binding Ninth Circuit and U.S. Supreme Court precedents for its holdings. In finding that EB-5 investments satisfy the Howey test's requirement of "an expectation of profit from the efforts of others," the court relied on the following observations:

• Even when investors primarily invest for reasons in addition to profit, they may have sufficient "expectations of profit" to find that the investments are securities.⁸ In other words, EB-5 investors could be investing to gain U.S. residency and investing for financial reasons.
• The EB-5 program regulations themselves state that the investors' capital must be "put at risk for the purpose of generating a return on the capital placed at risk."⁹
• While Feng argued that, subjectively, EB-5 investors did not expect a return on investment, the law instead focuses on whether the objective terms of the offering created an expectation of profit, and the terms of the EB-5 offerings in question did discuss the potential for profit.¹⁰
• Even if the investors must pay an administrative fee that is greater than potential profits, the court should not "conflate" fees and the purchase price in assessing whether the proceeds of an offering were intended to be profitable.¹¹

In arguing against treatment of EB-5 investments as securities, the defendants relied on United Housing Foundation, Inc. v. Forman, in which the Supreme Court suggested that for an instrument to be deemed a security, the investor must be "solely attracted by the...