By Elizabeth A. Whitman
A recent Wall Street Journal (WSJ) headline announced “SEC Looks Into Kushner Cos. Over Use of EB-5 Program for Immigrant Investors.”
It is not unusual to hear that a company is being investigated by the government over immigration issues. But, what is unusual about this particular investigation, however, is that it is being conducted by the Securities and Exchange Commission (SEC), which regulates securities, rather than the United States Citizenship and Immigration Services (USCIS), which regulates immigration and visas, including EB-5 visas.
To understand why the SEC has jurisdiction over Kushner Co.’s EB-5 program, one needs to go back more than 70 years.
In 1944, the then ten-year-old SEC failed to convince a Florida federal court that the sale of Florida orange groves with an optional management and production agreement (for buyers who did not have the knowledge to manage an orange grove themselves) was in the nature of agriculture and was not under SEC jurisdiction. A youthful, but determined SEC appealed but once again lost, when in 1945, a federal appeals court agreed with the Florida district court. Not to be outdone, the SEC appealed to the United State Supreme Court.
In 1946, the Supreme Court held in SEC v. W.J. Howey Co.  that the sale of the orange groves with the optional management agreement was an “investment contract” under the Securities Act of 1933. In Howey, the Supreme Court developed the investment contract test, which is still in use today. Simply put, a business dealing or transaction is an investment contract if:
- There is an investment of money (or other assets).
- The investment is in a common enterprise (generally this means a pooling of assets).
- There is an expectation of a profit.
- The profit comes from the efforts of a promoter or a third party.
The Howey test brings many routine transactions under securities law regulation, much to the chagrin of clients coming to me wanting to move into a new business venture. They may want to build a new hotel, buy and operate an assisted living community, flip houses, or engage in another commercial real estate project. They may want to buy an existing business, or they may have an idea for an entirely new business involving a cloud-based application or to provide a service to busy parents. Many times, those clients need funding to start their business or pursue their commercial real estate venture, and they may turn to friends and family to invest in their new business venture.
Many of these new businesses or commercial real estate investment structures, however, meet the requirements in the Howey test because they involve an investment of money by the family or friend into a common enterprise with an expectation of profits from the efforts of my client. Unfortunately for my clients, there is no securities exemption for investments by relatives or friends, so even though the only investors may be friends and family, my clients in those situations must comply with securities laws.
Indeed, over the years there has been a surprising variety in the types of investments which have been found to be investment contracts. Whiskey warehouse receipts, commercial real estate funds, pay phones and ATMs with placement contracts, interests in a lumber mill, fine art collections, certain time share arrangements, and, of course, investments as part of the EB-5 immigrant visa program have been found to be investment contracts subject to SEC regulation based upon the Howey test. Generally, those investments have involved situations in which investors expected a profit from a passive investment.
Further, when the stock market is high and there is a concern bond values might drop due to future interest rate increases, many people turn to alternative investments for diversification. Those alternative investments, traditionally available only to high income or high net worth accredited investors, include commercial real estate funds, oil and gas investments, and even musical instrument collections. For instance, even fine violins are becoming more popular as investments and could be sold to a syndication of investors. Most of those alternative investments are structured so that they are investment contracts under the Howey test.
Yet, not every investment in a common enterprise is an investment company subject to SEC regulation.
In 1975, the Supreme Court held in United Housing Foundation, Inc. v. Forman that investments in stock in a New York City cooperative housing project were NOT investment contracts even though the investors might expect a profit from that common enterprise from the efforts of the developer. The Supreme Court differentiated the housing cooperative from the investment in, for instance, the Howey orange groves or commercial real estate funds, because the primary purpose of the investment in the housing cooperative was to obtain housing, not to generate a profit.
Investors in EB-5 visa programs, are primarily investing to obtain one of a limited number of available annual immigrant visas from USCIS leading to conditional permanent resident status. To qualify, they must invest at least $500,000 ($1,000,000 under some circumstances) in an investment that results in the creation or preservation of a requisite number of permanent, full-time jobs for US workers.
EB-5 investors typically receive a small, fixed return on their investment, but their main incentive for investment is to obtain permanent resident status in the US, rather than to make a profit. Nevertheless, the SEC treats EB-5 investments as securities under the Howey test, and most reputable EB-5 sponsors attempt to comply with US securities laws when offering and selling EB-5 investments.
It’s not clear why the SEC is interested in Kushner Cos.’ EB-5 commercial real estate investment program. However, traditionally, the SEC has used its regulatory authority over EB-5 investments to combat fraudulent use of funds. For instance, in 2017, the SEC resolved a complaint against Serofim Muroff, an Idaho EB-5 sponsor, who allegedly used EB-5 money for his personal expenditures and for other projects outside of the purposes for which the investments were made. A similar case is underway involving EB-5 investments in Vermont ski resorts, which the SEC alleges were used by Ariel Quiros and his partner for personal expenditures.
Unless the SEC believes there has been a violation of securities laws, we may never find out why the SEC is interested in Kushner Cos.’ EB-5 program. However, what we do know is that the SEC has jurisdiction over a commercial real estate investment through a vehicle created by Congress to be administered by USCIS. That, in and of itself, should serve as a reminder to businesses, commercial real estate sponsors, and even to future violin syndicators that if they are asking others to invest money with the expectation of a profit, the securities regulators also may have jurisdiction over them, as well.
Before attempting to raise funds from third parties, everyone should consult with an experienced business and securities attorney, who can help assure that the transaction is in compliance with any applicable securities laws.
 Article by Erica Orden, The Wall Street Journal, Politics, January 6, 2018.
 SEC v. W.J. Howey Co., 60 F. Supp 440 (S.D. Fla. 1945).
 SEC v. W.J. Howey Co., 151 F.2d 714 (5th Cir. 1940).
 328 U.S. 293 (1946).
 There have always been investors interested in vintage violins. Some invest out of a philanthropic desire to support the arts, but yet, investments in violins can result in a steady gain in value, without the need to pay taxes on the gain until the violins are sold. According to a 2017 article by Emily T. Lane, President & Curator of Elan Fine Instruments, in Futures Magazine, interest in violin instruments has moved from the famous Cremonese masters, such as Stradivari and Guarneri del Jesu, which have a minimum value in seven figures, to more “moderately” priced instruments in the $100,000-$500,000 range, including Vuillaume (who was mentioned in my previous blog You Now Can Trade Up Your Violin, but Not the Bow or Case – New things to Consider in Section 1031 Exchanges After the 2017 Tax Law) and Balestrieri, an 18th century violin-maker from Mantua. See http://www.futuresmag.com/2017/01/21/investing-rare-violins . Although I am not aware of any violin-specific syndications, Liquidity Exchange (mentioned in the previous footnote) does offer a musical instrument syndication, which includes the possibility of investment in violins.
 421 U.S. 837 (1975).
 For more information about the EB-5 program, check out the USCIS website at https://www.uscis.gov/working-united-states/permanent-workers/employment-based-immigration-fifth-preference-eb-5/about-eb-5-visa-classification
© 2018 by Elizabeth A. Whitman
For more information, please contact Elizabeth A. Whitman at (301) 664-7713 or firstname.lastname@example.org