Why Must Private Investments in the United States Be Made Through SEC-Registered Professional Institutions and Personnel?

Author: ZeMing M. Gao 高泽明, Business Architect, U.S. IP Attorney; Expert in "Company as a Product" (CaaP), Intellectual Property, Blockchain, Tokenization, and Smart Contracts (Development/Strategy/Economics); SEC/FINRA Private Securities Registered Representative; Principal Advisor at Caapable, advising multiple companies; gao@caapable.com

– Investment Is Securities Trading –

In recent years, large volumes of Chinese capital have poured into the United States, bringing with them many business opportunities—but also increasingly exposing the blind spots Chinese capital holders have regarding the U.S. investment market.

Investment risk is a complex topic involving many factors, and is closely tied to industry type, business model, team composition, and stage of investment (seed, incubation, angel, early-stage venture capital, mid-to-late-stage venture capital, mergers and acquisitions, private equity, IPO, secondary market, etc.).

This article addresses only some of the most fundamental safety considerations in U.S. private equity investment.

Nearly all investment can be conceptually described as a form of "transaction"—specifically, a "securities transaction."

Broadly speaking, investment is in fact a special type of commercial purchase (transaction), except that what is being purchased is a financial product known as "securities."

The most typical form of securities is equity, and equity is concretely represented by the well-known instrument of shares.

Yet people often forget—or are entirely unaware—that in the United States, securities trading is a strictly regulated industry.

That is to say, securities are a special class of commodity, and only individuals with special qualifications may provide trading services for them.

The term "regulated" carries a particular meaning and is not merely a general requirement of legality. The securities industry, like medicine, law, and accounting, is a regulated profession—but in many respects, owing to its unique risks, the securities industry is regulated to a far greater degree than other fields.

The U.S. securities industry is governed uniformly by the federal agency Securities Exchange Commission (SEC). The SEC is analogous to China's CSRC (China Securities Regulatory Commission, a ministerial-level government body under the State Council), except that the SEC has a much longer history, is far larger in scale, and operates through a far more systematic framework.

The SEC's control over securities transactions is exercised primarily not through direct regulatory intervention, but through Financial Industry Regulatory Authority (FINRA), which oversees the professionals working in the financial industry.

In other words, under normal circumstances, the SEC does not directly intervene in financial transactions. Instead, it achieves oversight indirectly by supervising, through FINRA, the professional institutions and individuals engaged in the financial industry.

This regulation manifests more specifically in two ways:

1. High entry barriers – strict registration and qualification examination requirements;
2. Strict disciplinary oversight – rigorous disciplinary and penalty regulations.

The necessity of such regulation began to be recognized following the Great Depression of the late 1920s. While fraud exists in every industry, experience has shown that the temptation and incentive for fraud is particularly pronounced in the securities industry. More alarmingly, because of the securities industry's inherently speculative nature, a person handling securities can in good conscience feel they are acting entirely normally—yet through ignorance produce results indistinguishable in effect from outright fraud.

Securities can be broadly divided into two major categories:

1. Private securities
2. Publicly traded securities

Private securities encompass all fundraising by non-publicly-listed companies, mergers and acquisitions, and initial public offerings (IPOs); publicly traded securities refer to the trading of listed companies on stock exchanges (known as the "secondary market").

Given the different nature of these two types of securities transactions, the SEC/FINRA maintains distinct professional registration and oversight requirements for practitioners in each area.

When coming to the United States to invest—whether for ordinary business purposes or for immigration purposes (EB-5 investor immigration)—the first step is to find a qualified professional registered with the SEC/FINRA.

This may sound like an obvious requirement, yet it is widely overlooked at present. This is partly due to a lack of understanding of the nature of the securities industry, but it is also related to the habits and culture of the Chinese business community.

Chinese people are accustomed to relying on personal connections, so when they come to the United States they turn to acquaintances or friends, assuming that so long as they can find someone they trust, everything can be managed. This mindset has a valid core, because trust is indeed the most fundamental element of doing business.

Even in the United States, personal relationships are very useful—this is simple human nature. But the more important principle when doing business in the United States is: you must find someone who is both trustworthy and professionally competent. Neither alone is sufficient.

In the United States, most professionals are trustworthy. While one should not be blindly credulous, one cannot distrust everyone either—otherwise, many things in America, including business matters, simply cannot get done.

The absence in Chinese society of this kind of formal trust relationship between professionals and clients is one of the significant reasons why transaction costs and risks are so high there.

In China, trust is an essentially personal feeling generated primarily through personal relationships. In the United States, that personal trust is equally important—again, this is human nature—but layered on top of it is an additional form of trust generated through one's profession, especially with practitioners of regulated professions such as lawyers, doctors, accountants, and securities advisors.

It is to be hoped that investors coming from China will gradually come to understand a major difference between the Chinese and American business environments and cultures: in the United States, the vast majority of things can be accomplished legally and honestly. This stands in marked contrast to the situation in China. This difference takes time and practical experience to appreciate, because even those who understand it in principle often still take the wrong path in practice.

It is worth noting that the current confusion in the investment community does not stem solely from Chinese investors—it is also related to Chinese Americans who have lived and worked in the United States for years. The surge in Chinese investment capital has led increasing numbers of Chinese Americans to seek opportunities in this industry. The business acumen and adaptability of Chinese people are tremendous assets, but they can also lead, without anyone realizing it, to business practices that run afoul of regulations.

– Prohibited Conduct in Private Placement –

Prohibited Act, Example One: Unless one holds a registered SEC/FINRA private securities qualification, it is impermissible to introduce investors to a private placement project and receive a "success reward" (success fee) in return. The definition of "success reward" here is broad: it encompasses compensation in any form—including deferred or non-cash compensation—so long as any agreement or understanding between the fundraiser and the introducer links the "reward" to a "successful introduction." All such arrangements constitute prohibited conduct.

Prohibited Act, Example Two: Unless an individual or institution is the issuer of the securities or holds registered SEC/FINRA private securities qualifications, it is impermissible to sell or solicit private securities (private placements). Moreover, even those who hold the requisite qualifications are subject to strict limitations on the manner in which they may advertise and promote. (You may have noticed that private placement advertisements are essentially nowhere to be seen in the United States. There is a reason for this—it is not that people here do not know how to do business, but that the law prohibits it. This is precisely why the most compliant private placements maintain the lowest profiles, and why you are unlikely to hear about them through mainstream media.)

It is clear that by this standard, many private placement activities currently circulating in Chinese-American communities are likely non-compliant.

Note: Information on the SEC/FINRA registration qualifications (federal and state) of private securities professionals can be found on the SEC's official website (www.adviserinfo.sec.gov) or FINRA's official website (brokercheck.finra.org): simply enter the person's English name or registration number to verify. Both websites are official, contain the same verification information, and can be used to verify any institution or individual. If a search yields no results, you can be certain that the institution or individual does not hold SEC/FINRA qualifications.

A Case Study: EB-5 Investor Immigration

In some respects, EB-5 investor immigration is a peculiar example in which many of the latent problems described above occur universally and in the most extreme forms.

At present, the vast majority of EB-5 private placement fundraising is conducted by individuals and institutions that lack legitimate SEC/FINRA qualifications and professional credentials. In other words, fundraising in the current EB-5 space is essentially conducted in violation of the rules. This pervasive non-compliance is one of the primary causes of risk in EB-5 investing. It is no wonder the field is rife with risks and alarming news stories.

That said, fully compliant projects and services that adhere to SEC private securities regulations—along with the oversight institutions that enforce them—do exist. They are simply not yet numerous, and it is often precisely their compliance that renders them less visible.

If you are not familiar with U.S. securities markets and regulation, or with the inner workings of the EB-5 industry, this characteristic may not immediately strike you as noteworthy.

But you might ask:

What benefit does compliance offer me?

Answering this question requires understanding the function of the U.S. SEC. The sole purpose of the SEC is to protect investors (not to protect the careers of financial professionals).

The SEC does not exist to make trouble for people or spoil legitimate business dealings. The existence of the SEC is the primary reason the U.S. investment landscape enjoys a relatively high degree of reliability overall.

In fact, investors have already been indirectly protected by the SEC in the past. In several major EB-5 fraud cases, SEC intervention substantially reduced investor losses. But this kind of after-the-fact intervention—responding only after something has gone wrong—is far from sufficient.

The SEC does not actively monitor individual projects; it may intervene only in extreme cases, such as after a large-scale fraud has been exposed. And even when the SEC does intervene, it can only salvage funds that have not yet been dissipated—it cannot provide any assistance with an investor's green card application itself, because that is not the SEC's concern.

The protective benefits of SEC regulations can only be proactively realized through institutions and professionals who hold SEC registration qualifications. Specifically, investors must actively choose legitimate U.S. institutions and professionals with the due diligence and oversight capabilities required by SEC private securities regulations in order to fully benefit from those regulations.

Currently, most EB-5 fundraising does not go through institutions—such as investment banks—that comply with U.S. SEC regulations and hold proper securities transaction qualifications. Intermediaries, seeking to maximize their own profits, generally bypass investment banks and similar institutions.

The problem, however, is that doing so transfers the risk onto investors.

Without a properly registered individual or institution (such as an investment bank) serving as a gatekeeper, there is no one positioned to vet projects and protect the safety of applications from the investor's perspective. As mentioned earlier, the SEC prohibits these practices for good reason. The sole purpose of the U.S. SEC is to protect investors.

Bypassing SEC-authorized professional institutions and individuals is, in effect, forgoing the protections afforded by SEC regulations.

Because—aside from pursuing a few individual large-scale frauds after the fact—the protective effect of SEC regulations is realized through the oversight of professional institutions and individuals engaged in the financial industry. If investors do not work through SEC-authorized professional institutions and individuals, they are in effect voluntarily surrendering those protections.

You might ask: of course compliance is good, but surely it should be a baseline standard—

Can it really be that so many EB-5 fundraising operations, conducted openly in broad daylight, are non-compliant?

The fact is that non-compliant practices are not the exception but the rule in private placements commonly seen among Chinese-American communities. Even within the SEC-permitted "venture fund exemption," many funds are in practice non-compliant because they are not structured in accordance with what the law actually requires. (One of the basic requirements for a venture fund: the fund must follow venture fund principles—raise capital first, then invest. It cannot source a project first and then go looking for investors.)

Some might retort: that is all very well, but without a concrete project in hand, how would investors trust you enough to give you their money?

But this is precisely why the SEC permits the "venture fund exemption" in the first place. In the eyes of securities law, if a venture fund—as an institution—can raise capital for the fund itself without selling any specific project, this is analogous to a startup company finding investors for itself without going through an intermediary. In such a case, regulation need not interfere, unless the fundraiser acts dishonestly or misleads investors during the fundraising process.

But if the fund lacks this capability and can only raise capital by presenting a specific project, then the "fund" effectively ceases to exist as such, and the fundraiser is playing the role of a securities broker. In that scenario, fundraising without SEC registration qualifications constitutes a violation. This is precisely the intent of securities law.

The situation in the EB-5 space is even more disorderly. It is fair to say that most EB-5 fundraising has historically been conducted in violation of the rules, and given the near-monopoly that intermediaries hold over the market, this situation is unlikely to improve quickly. This pervasive non-compliance is one of the primary causes of risk in EB-5 investing.

You might find this puzzling. The United States is a highly law-governed society—how could an entire industry operate in systematic violation of the rules? Surely this is an exaggeration.

It is indeed a strange phenomenon, but it is related to the unique history and characteristics of investor immigration. The reasons are twofold.

First, throughout the more than twenty years of EB-5 history—until just recently—the number of applicants remained very small. From the perspective of the business and financial world, it was an industry of negligible scale. As a result, not only did it fail to attract sufficient U.S.-based professionals, it also failed to attract the attention of the SEC. The field thus became a kind of regulatory "Wild West."

At the same time, the immigration authorities concerned themselves only with requirements under immigration law, and neither had the authority nor the competence to address the more fundamental underpinning of EB-5—namely, that investor immigration is at its core an investment and business development activity, and that the risks stem from precisely that nature.

And then EB-5 happened to encounter China. Over the past decade, more than 90 percent of the EB-5 market came from China, and nearly all EB-5 projects depended on Chinese intermediaries to market to investors. This type of investment solicitation, if conducted in the United States, would be illegal. Not only do the intermediaries lack lawful SEC private securities qualifications, but U.S. securities law would not permit such high-pressure, sensationalist marketing methods and content even from those who did hold the requisite qualifications.

However, the U.S. SEC has no direct jurisdiction over foreign intermediaries. While in theory the SEC could require foreign intermediaries to hold at least a lawful private securities qualification in their home country, the complexity and unreliability of enforcing such a requirement means that this has not yet been implemented in practice.

The result: most EB-5 fundraising is currently not conducted through institutions—such as investment banks—that comply with U.S. SEC regulations and hold proper securities transaction qualifications. Intermediaries, seeking to maximize their own profits, generally bypass investment banks and similar institutions.

The problem, however, is that doing so transfers the risk onto investors (see the discussion above).

What Is the Ideal Approach?

Given the diversity of the investment landscape, it is difficult to prescribe a single ideal approach. However, in order to meaningfully improve the safety of an investment, the following conditions should be observed:

(1) Partner with a legitimate investment bank for project selection and oversight;

(2) Key principals, as well as advisors who directly handle investment projects and interface with investors, should all possess the professional competence and qualifications for investment securities—specifically, having passed the SEC/FINRA (the U.S. financial industry regulatory authority) private securities professional examinations and obtained the corresponding credentials;

(3) Practitioners should possess multi-disciplinary U.S. professional competence and extensive experience—including in law, business, and finance—to provide comprehensive (commercial, financial, and legal) authoritative interpretation, review, and oversight of the entire process.

The above requirements must be substantively fulfilled, not merely observed in name for the sake of compliance. They must genuinely provide a basic level of security for the investment. SEC/FINRA registration qualifications for U.S. private securities require passing a series of professional examinations. This is not a formality. It represents the foundational competence for identifying and assessing investment risk.

– Fees –

Will the involvement of legitimate investment banks and registered professionals result in higher costs for investors?

In fact, the costs and fees investors currently bear are already very high. In many cases, investors believe they are saving money, when in reality, the potential costs arising from non-compliance and lack of transparency are extremely high—sometimes in the form of direct fees, sometimes as risk costs, and sometimes as opportunity costs.

The involvement of legitimate investment banks and registered professionals should be funded through a reasonable reallocation of existing fee structures. This will inevitably reduce the profit margins of intermediary services, but this is necessary—otherwise, it is a failure of responsibility toward investors.

In a compliant model, fees are paid to U.S. investment banks and professionals. If the investment bank represents the issuer, these fees are borne by the issuer. From the investor's perspective, this may feel like "the customer ultimately pays." Even so, the services provided represent genuine value for money, because they offer substantive benefits to the investor—particularly in terms of safety. This is a transparent fact. By contrast, when non-qualified intermediaries are used, there are often many hidden costs (to say nothing of hidden risk costs). For example, in EB-5 projects, investors typically pay the project sponsor a substantial "administrative fee." What investors often do not know is that this money is essentially wasted, because it is passed under the table by the project sponsor to the intermediaries—intermediaries who typically bypass investment banks and deal directly with the project.

The key question about fees is: what is the money actually being spent on?

To use an analogy: if you have a construction project, and a large portion of the budget is allocated to safety features—fire protection, security, earthquake resistance, and so on—that is obviously necessary. But if after paying the money, your contractor fails to implement any of those measures and instead quietly passes the funds to the middleman who brought them the job, then you have been cheated.

What is alarming, however, is that this is precisely what happens routinely in private placements—and especially in EB-5 investing.

Overall, the most prevalent and consequential risk factor in the current private placement landscape is directly related to the following reality:

The vast majority of participating institutions and individuals do not hold professional SEC qualifications for U.S. private securities. The risks that flow from this are man-made and can be minimized through careful selection of professional institutions and individuals who hold SEC qualifications.

Is Going Without an Immigration Agent Safe?

Beyond the projects promoted by immigration intermediaries, there is another category of EB-5 projects widely advertised in China—projects that claim to come directly from the United States, representing the project sponsor directly, without going through intermediaries. These projects are in fact riskier.

The interests of project sponsors who go directly to China to raise capital are fundamentally different from those of immigration intermediaries. Intermediaries are focused on the management fees and service fees they collect from investors; project sponsors, on the other hand, have their eyes on investors' principal—and on the investment returns that capital generates—amounts far greater than management and service fees. Their motivations are therefore often tied to far greater risks.

Institutions and individuals who go to China to directly market investment projects, even if their intentions are not fraudulent, are currently employing high-profile, large-scale, public solicitation methods for private placements that do not comply with U.S. regulatory requirements—and thus carry substantial risk.

Very few of the people promoting these projects currently hold U.S. SEC/FINRA registration qualifications. They are simply doing business in China while circumventing the SEC. (Remember: information on the SEC/FINRA registration qualifications of U.S. private securities professionals can be