The SEC’s Latest C&DIs Related to Bad Actor Disqualification

Last week, on Wednesday, the Securities and Exchange Commission’s Division of Corporation Finance issued 14 new Compliance and Disclosure Interpretations (C&DIs) related to the private offering exemption afforded by Regulation D, Rule 506, this time addressing subsection (d) of the rule (concerning bad actor disqualification). The new C&DIs are summarized below (in seventeen bullet points):

When to make the disqualification determination …

  • An issuer must determine whether it is subject to bad actor disqualification under Rule 506(d) any time it is offering or selling securities in reliance on Rule 506. If an issuer is not offering or selling securities in reliance on Rule 506 then it need not determine whether Rule 506(d) applies unless and until it commences a Rule 506 offering. [260.14]
  • An issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event (e.g., pursuant to a contractual covenant, bylaw requirement or an undertaking in a questionnaire or certification). However, if an offering is continuous, delayed or long-lived, the issuer must update its factual inquiry periodically through bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances. [260.14]

What if there’s a disqualifying event mid-offering …

  • An issuer that uses a placement agent can continue to rely on Rule 506 if that placement agent or one of its covered control persons (e.g., an executive officer or director) becomes subject to a disqualifying event while the issuer’s offering is ongoing, provided that: (i) if the triggering disqualifying event affects the placement agent, the placement agent’s engagement is terminated and it does not receive compensation for sales occurring after the disqualifying event; or (ii) if the triggering disqualifying event only affects a covered control person of the placement agent, that covered control person is terminated or no longer occupies a role with respect to the placement agent that would cause such person to be a covered control person for purposes of Rule 506(d). [260.15]

Who’s covered by Rule 506(d) …

  • An “affiliated issuer” of an issuer means an “affiliate”–defined in Rule 501(b) as a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the issuer–that is issuing securities in the same offering, including offerings subject to integration (see 130.01 and 130.02 for examples of co-issuer or multiple issuer offering); as opposed to every affiliate of an issuer that has issued securities.[260.16]
  • All persons who have been or will be paid, directly or indirectly, remuneration for the solicitation of purchasers are compensated solicitors covered by Rule 506(d), regardless of whether they are, or are required to be, registered as a broker-dealer or are associated persons of a registered broker-dealer.[260.17]

What counts as participation …

  • A person whose sole involvement in an issuer’s Rule 506 offering is as a member of the compensated solicitor’s deal or transaction committee that is responsible for approving the solicitor’s participation in the offering does not fall within the meaning of a person who is “participating” in the offering. [260.18]
  • Participation in a Rule 506 offering is not limited to the solicitation of investors, other examples of participation include participation or involvement in due diligence activities or the preparation of offering materials (including analyst reports used to solicit investors), providing structuring or other advice to the issuer in connection with the offering, and communicating with the issuer, prospective investors or other offering participants about the offering.[260.19]
  • To constitute participation for purposes of Rule 506, such activities must be more than transitory or incidental. Administrative functions, such as opening brokerage accounts, wiring funds, and bookkeeping activities, would generally not be deemed to be participating in the offering.[260.19]

What happens in a foreign jurisdiction …

  • Disqualification under Rule 506(d) is not triggered by actions taken in jurisdictions other than the United States (e.g., convictions, court orders or injunctions in a foreign court, or regulatory orders issued by foreign regulatory authorities). [260.20]

Orders, judgments and decrees …

  • Disqualification under Rule 506(d)(1)(v) is triggered only by orders to cease and desist from violations of scienter-based provisions of the federal securities laws, including scienter-based rules. An order to cease and desist from violations of a non-scienter based rule would not trigger disqualification under Rule 506(d)(1)(v), even if the rule is promulgated under a scienter-based provision of law (e.g., an order to cease and desist from violations of Exchange Act Rule 105 would not trigger disqualification under Rule 506(d)(1)(v), even though Rule 105 is promulgated under Exchange Act Section 10(b)). [260.21]
  • Rule 506(d)(2)(iii) is self-executing and, as such, if an order, judgement or decree is issued by a court or regulator in accordance with Rule 506(d)(2)(iii) advising that disqualification from Rule 506 should not arise as a consequence of the order, judgement or decree then it is not necessary for an issuer to separately seek a waiver from the Commission or to take any other action to confirm that bad actor disqualification will not apply. [260.22]

The reasonable care exception …

  • The reasonable care exception to disqualification applies whenever an issuer can establish that it did not know and, despite the exercise of reasonable care, could not have known that a disqualification existed under Rule 506(d)(1). This may occur when, despite the exercise of reasonable care, the issuer was unable to determine the existence of a disqualifying event, was unable to determine that a particular person was a covered person, or initially reasonably determined that the person was not a covered person but subsequently learned that determination was incorrect. [260.23]
  • Issuers still need to consider what steps are appropriate upon discovery of Rule 506(d) disqualifying events and covered persons throughout the course of an ongoing Rule 506 offering. An issuer may need to seek waivers of disqualification, terminate the relationship with covered persons, provide Rule 506(e) disclosure, or take such other remedial steps to address the Rule 506(d) disqualification. [260.23]

What to (and not to) disclose …

  • The disclosure obligation set forth in subsection (e) of Rule 506–the obligation to disclose past events that would have been disqualifying events, except that they occurred prior to Rule 506(d)’s September 23, 2013 effective date–are not subject to waiver. [260.24]
  • Rule 506(e) only requires disclosure of events that would have triggered disqualification at the time of the offering had Rule 506(d) been applicable. Because events outside the applicable look-back period and orders that do not have continuing effect (e.g., a criminal conviction that occurred more than ten years before the offering or an order or bar that is no longer in effect at the time of the offering) would not trigger disqualification, Rule 506(e) does not mandate disclosure of such matters in order for an issuer to be able to rely on Rule 506. [260.25]
  • In an offering in which an issuer uses multiple placement agents or other compensated solicitors the issuer must provide Rule 506(e) disclosure for all compensated solicitors and their covered control persons (i.e., general partners, managing members, directors, executive officers, etc.) involved in the offering to all investors at the time of sale (regardless of which compensated solicitor solicited the investors). [260.26]
  • In a continuous offering an issuer must provide disclosure under Rule 506(e) with respect to all compensated solicitors that are involved with the offering at the time of sale, however the issuer need not provide disclosure under Rule 506(e) with respect to compensated solicitors that were previously but no longer are involved with the offering. [260.27]
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