Interpretive Letter to Brian Sweeney, Trustmont Financial Group, Inc.
August 26, 2013
Mr. Brian Sweeney
Trustmont Financial Group, Inc.
200 Brush Run Road
Greensburg, PA 15601
Re: Request for Interpretive Guidance on FINRA Rule 2111 (Suitability) in Relation to EB-5 Program Securities Transactions
Dear Mr. Sweeney:
By letter dated April 25, 2013, you request guidance on the applicability of FINRA Rules, and in particular Rule 2111 (Suitability), to FINRA members' recommendations of securities transactions in connection with the EB-5 Immigrant Investor Program (EB-5 Program).
Trustmont Financial Group, Inc. (Trustmont) is a registered broker-dealer and FINRA member that is considering whether to offer investors securities in connection with the EB-5 Program. The Immigration and Nationality Act of 1990 provides a method for foreign nationals to obtain U.S. residency by investing in domestic projects that will create or preserve a minimum number of jobs for U.S. workers. Known as the EB-5 Program and administered by the U.S. Citizenship and Immigration Services, this program provides that foreign nationals may qualify to obtain U.S. residency if individuals invest $1,000,000 (or at least $500,000 in a "Targeted Employment Area" – i.e., a high unemployment or rural area) in a project that creates or preserves at least 10 jobs for U.S. workers, excluding the investor and his or her immediate family.
You state that "EB-5 programs are typically sold as fractional interests in a pool of investor assets under one of the exemptions from registration such as Regulation D or S" promulgated under the Securities Act of 1933 and that the Securities and Exchange Commission has determined that EB-5 transactions so structured are securities. You suggest that FINRA should not exercise jurisdiction over securities transactions related to the EB-5 Program 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[.]" You also opine 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."
As a FINRA member firm, Trustmont must comply with FINRA rules. 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. In this regard, as you note in your letter, the SEC recently filed a civil action in federal court alleging securities fraud in connection with EB-5 Program securities transactions.1
You ask about the applicability of FINRA Rule 2111 to EB-5 Program securities transactions. Because your letter focuses on the EB-5 Program, which is designed to allow foreign nationals to obtain U.S. residency through investment in domestic projects, our response is limited to members' recommendations of securities or investment strategies involving securities to foreign nationals seeking, among other things, U.S. residency.
To the extent that a FINRA member recommends a security or investment strategy involving a security to a foreign national in connection with the EB-5 Program, the suitability rule would apply to the recommendation. The 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.
Your main concerns center on two suitability obligations: reasonable-basis and customer-specific suitability. Under the reasonable-basis obligation, a broker-dealer must 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. See FINRA Rule 2111.05(a).
FINRA provided extensive guidance on this reasonable-basis obligation as it relates to Regulation D offerings in Regulatory Notice 10-22 (Apr. 2010). 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." In the context of a private placement related to the EB-5 Program that a broker-dealer intends to recommend to foreign nationals seeking investment returns and U.S. residency, these same issues should be explored, issues that address the legitimacy and viability of the issuer's enterprise. 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.
As to the customer-specific obligation, a 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. See FINRA Rules 2111(a); 2111.05(b). A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, and risk tolerance. See FINRA Rules 2111(a); 2111.04. In addition to these specific factors, a customer's investment profile also would include any other information the customer may disclose to the member or associated person in connection with a recommendation, such as particular goals with respect to an investment.2 For instance, when a customer is a foreign national who discloses to the member that he or she is seeking U.S. residency by investing in an EB-5 Program securities transaction, such information would become part of the customer's investment profile and must be considered when determining whether the recommended investment is suitable for the particular customer. In this situation, among other customer-specific considerations, the member 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.
We trust that this letter is responsive to your request. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the FINRA Board of Governors. This letter responds only to the issues you have raised based on the facts as you have described them and FINRA Rule 2111, and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved. In addition, you should be aware that any changes in the facts as you have described them or any amendments to FINRA Rule 2111 will require further consideration and may cause us to reach a different conclusion.
If you have any questions on this matter, please contact Matthew E. Vitek at (202) 728-8156 or me at (202) 728-8270.
James S. Wrona
|cc:||Robert B. Kaplan|
Vice President and District Director
Philadelphia District Office
1 See SEC v. A Chicago Convention Center, et al., No. 13CV982 (N.D. of Ill. Feb. 6, 2013), at http://www.sec.gov/litigation/complaints/2013/comp-pr2013-20.pdf (complaint) and http://www.sec.gov/news/press/2013/2013-70-order.pdf (order modifying asset freeze).
2 See FINRA Rules 2111(a); 2111.04. FINRA recognizes that the "significance of specific types of customer information will depend on the facts and circumstances of the particular case." Regulatory Notice 12-25, at 11 (May 2012); FINRA Rule 2111.04.