It is now widely understood that EB-5 capital raises involve securities that must be registered with the Securities Exchange Commission (SEC) unless the securities are offered pursuant to a valid securities exemption. At the federal level, EB-5 capital raises have generally relied upon two primary securities exemptions: Rule 506 of Regulation D and Regulation S. Each has its benefits, but is not without drawbacks. This article explores the emergence of Rule 504 of Regulation D as another possible securities exemption for smaller EB-5 capital raises.
Rule 506 of Regulation D
While Regulation D historically consisted of three primary exemptions, the most commonly used exemption by far was Rule 506. One reason for this is that Rule 506 has no limit on the amount of capital that can be raised under that exemption while the two other Reg D exemptions were historically limited to maximum raises of $1,000,000 under Rule 504 or $5,000,000 under Rule 505. Another reason is that of the Regulation D exemptions, only Rule 506 allows for preemption of state securities laws with respect to registration of securities. In other words, companies offering securities under the exemption afforded by Rule 506 are also generally exempted from registration under the various state blue sky laws.
Rule 506 has been wildly popular and is now relied upon by companies to raise over a trillion dollars a year. Companies choosing Rule 506 have two options: Rule 506(b) or Rule 506(c). Rule 506(b) prohibits general solicitation and advertising of the capital raise, but companies can rely on investors’ self-certification that they are accredited investors (and they can even take some non-accredited investors). Rule 506(c) allows for general solicitation and advertising to anyone (including non-accredited investors), but companies must prove the accredited investor status of those that end up investing.
Rule 506(b) has practical limitations in the EB-5 market as companies are forced to rely on private networks since they can’t generally solicit and advertise their securities offerings. Nevertheless, Rule 506(b) has been popular in EB-5 because there does exist an infrastructure of private networks established by many key players in the EB-5 space which allows companies to successfully conduct private offerings.
For EB-5 capital raises, Rule 506(c) is particularly powerful and since its adoption in 2013, it has seen increasing usage. The reason for this is that Rule 506(c) allows companies seeking EB-5 capital to generally solicit investors not just in the US, but anywhere in the world (subject to foreign laws which may be applicable, of course). This is particularly helpful for companies who don’t generally have their own private network of investors and who don’t want to play within the private network established by others. However, Rule 506(c) requires not only that all investors are accredited investors, but also that the company take federally prescribed “reasonable steps” to prove that the investors are indeed accredited investors. While proving accredited investor status isn’t necessary that difficult for EB-5 investors who tend to be wealthy already, it’s another hurdle in an already onerous immigration process.
Regulation S has been heavily relied upon in the EB-5 market as well. Reg S exempts offers and sales of securities “that occur outside the United States” from the obligation to register securities under federal law. In a nutshell, securities offerings may qualify for the Reg S exemption if they are made in an offshore transaction to non-US Persons in a manner that doesn’t condition the US market. There are guidelines that explain what is considered an offshore transaction, who is a US Person, and what it might mean to condition the US market, but that discussion is beyond the scope of this article.
Reg S, however, has its own limitations. First, it doesn’t allow for a company to accept any US Persons as investors. Also, Reg S is only a federal securities exemption and does not preempt state securities laws. In other words, companies offering securities under the exemption afforded by Reg S must still find an exemption under state blue sky laws to comply with state securities laws. Unfortunately, many states do not have a Reg S equivalent. Unless a company is able to find a standalone state securities exemption to rely upon, conducting a federally compliant Reg S capital raise could still cause them to have an illegal offering at the state level.
When conducting an EB-5 securities offering utilizing Rule 506 or Reg S, a company has several options: (i) only use Rule 506; (ii) only use Reg S; (iii) conduct a single offering that qualifies under both the Rule 506 exemption as well as the Reg S exemption (safest, but most restrictive); or iv) conduct a simultaneous but separate offering under Rule 506 and Reg S (must be carefully done). It’s best to consult with a securities attorney experienced with the interplay between Rule 506 and Reg S. There may be situations where relying on a single exemption is superior to attempting to utilize multiple exemptions. A number of prominent securities attorneys in the EB-5 space have suggested that Rule 506(c) may be a superior exemption when compared with Reg S, and that relying on Rule 506(c) by itself is sufficient without any need to utilize Reg S.
Historically, Rule 504 of Regulation D saw limited usage. Rule 504 does not preempt state laws and was limited to aggregate capital raises of $1,000,000 or less in a twelve-month period. Effective as of January 20, 2017, however, the $1,000,000 limit on Rule 504 was increased to $5,000,000, making the Rule 504 exemption significantly more useful for smaller capital raises.
Rule 504 is attractive because if the offering is conducted without general solicitation and advertising, non-accredited investors may invest without the company needing to comply with the additional sophistication or heightened information requirements associated with accepting non-accredited investors in Rule 506(b) offerings. If the company chooses to generally solicit or advertise their securities to the public and sell unrestricted securities, then they must sell only to accredited investors and register the offering at the state level.
For EB-5 offerings by issuers who can conduct the offering through private networks without general solicitation or advertising, Rule 504 is a securities exemption worth considering. The ability to accept non-accredited investors, including US Persons, may allow a capital raise to a larger available pool of investors such as foreign students who may not be accredited investors. Companies conducting smaller EB-5 capital raise of $5,000,000 or less should ask their securities attorney if Rule 504 works for them. It’s important to remember that anyone relying on Rule 504 for a federal exemption will need a separate exemption under state law. Luckily, there generally are state exemptions available for non-generally solicited offerings conducted under the Rule 504 exemption.
 Rule 504, Rule 505, and Rule 506 were the three primary exemptions of Regulation D, but Rule 505 will be repealed on May 22, 2017.
 Note, however, that the preemption does not affect all types of securities or all types of persons. Additionally, while an issuer may not have to register or qualify the securities under the various states’ blue sky laws, it may still be required by some states to pay certain fees and make notice filings.
 Notwithstanding the ability to accept non-accredited investors, most companies limit their Rule 506(b) offerings to only accredited investors due to the extra burdens, such as sophistication and heightened information requirements, imposed if they accept non-accredited investors.
 SEC Staff has previously suggested that investor residence is determined to be the country where the investor permanently, rather than temporarily, resides. Notwithstanding such prior commentary, most securities attorneys advise a more conservative route of not accepting accept investment from anyone in the US, including foreign students studying in the US or workers here on H-1B visas, even though those persons are may be only temporarily living in the US.