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Last Friday the Division of Corporation Finance released another set of Compliance and Disclosure Interpretations (C&DIs), mostly related to subsection (d) of the private offering exemption afforded by Regulation D, Rule 506 (bad actor disqualification) and the determination of beneficial ownership for purposes bad actor disqualification.

To briefly recap: Rule 506 contains a “bad actor” disqualification provision which provides, in relevant part, that the Rule is unavailable if an issuer of securities or any number of persons associated with that issuer (predecessors, directors, executive officers, etc.) including “any beneficial owner of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power … ” is a bad actor, as defined in subsection (d) of the Rule.

The new C&DIs are summarized below (you’ll note that there are a lot of bullet points but really only five C&DIs related to Rule 506 were released):

When does a shareholder become a beneficial owner …

  • The bad actor disqualification determination must be made at the time of each sale of securities. Rule 506(d) provides that no exemption will be available for a sale if any covered person is subject to a bad actor triggering event at that time. A shareholder that becomes a 20% beneficial owner upon completion of a sale of securities is not a 20% beneficial owner at the time of the sale; however, such shareholder would be a covered person with respect to any sales of securities that are made while it was a 20% beneficial owner. [260.28]

How to determine beneficial ownership for Rule 506(d) …

  • The term “beneficial owner” in Rule 506(d) is interpreted in the same way as under Exchange Act Rule 13d-3, to mean any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares, or is deemed to have or share: (1) voting power, which includes the power to vote, or to direct the voting of, a security; and/or (2) investment power, which includes the power to dispose, or to direct the disposition of, a security. [260.29]
  • Beneficial ownership includes both direct and indirect interests, determined in the same way that beneficial ownership is determined under Exchange Act Rule 13d-3, as such it is necessary to look through entities to determine beneficial ownership. [260.30]
  • Beneficial ownership of group members and groups should be analyzed in the same way as under Exchange Act Rule 13d-3 and 13d-5(b): [260.31]
    • Shareholders that enter into a voting agreement under which each shareholder agrees to vote its shares of voting equity securities in favor of director candidates designated by one or more of the other parties to the voting agreement have formed a group, and the group beneficially owns the shares beneficially owned by its members. [260.31]
    • Parties to the voting agreement that have or share the power to vote or direct the vote of shares beneficially owned by other parties to the agreement (e.g., through receipt of an irrevocable proxy or the right to designate director nominees for whom the other parties have agreed to vote) will beneficially own such shares. [260.31]
    • Parties to the voting agreement that do not have or share the power to vote or direct the vote of other parties’ shares would not beneficially own such shares solely as a result of entering into the voting agreement. [260.31]
    • If a group is a 20% beneficial owner, then bad actor disqualification or disclosure obligations would arise from court orders, injunctions, regulatory orders or other triggering events against the group itself. [260.31]
    • If a party to the voting agreement becomes a 20% beneficial owner because shares of other parties are added to its beneficial ownership, bad actor disqualification or disclosure obligations would arise from triggering events against that party. [260.31]

More on bad actor disclosure obligations …

(Bad actor disclosure obligations were also addressed in CorpFin’s last set of C&DIs.)

  • An order issued by a court or regulator, in accordance with Rule 506(d)(2)(iii), does not waive the bad actor disclosure requirements of Rule 506(e). [260.32]
  • Rule 506(e) pertains to an issuer’s obligation to provide disclosure of disqualifying events that would have triggered bad actor disqualification, except that these events occurred before September 23, 2013. [260.32]
  • Rule 506(d)(2)(iii) permits issuers to rely on the self-executing statement of a regulatory authority to avoid Rule 506 disqualification when that regulatory authority advises the Commission in writing or in its order, decree or judgment, that Rule 506 bad actor disqualification should not arise as a consequence of a disqualifying event that occurred on or after September 23, 2013. [260.32]
  • A regulatory authority such as a state securities commission may, however, determine that an order entered before September 23, 2013 would not have triggered bad actor disqualification because the violation was not a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before such sale. (emphasis mine) [260.32]

Finally, CorpFin also released one C&DI related to the determination of beneficial ownership under Exchange Act Sections 13(d) and 13(g) and the reporting requirements of Regulation 13D-G (it pretty much mirrors the guidance of C&DI 260.31, but addresses the determination of beneficial ownership as it relates to shareholders of Exchange Act reporting issuers):

  • The formation of a group under Rule 13d-5(b), without more, does not result in the attribution of beneficial ownership to each group member of the securities beneficially owned by other members. [105.06]
  • Under Section 13(d)(3) of the Exchange Act, a group is treated as a new “person” for purposes of Section 13(d)(1), and a group is deemed to have acquired, by operation of Rule 13d-5(b), beneficial ownership of the shares beneficially owned by its members. (CorpFin notes that the analysis is different for Section 16 purposes. See Section II.B.3 of Exchange Act Release No. 28869) [105.06]
  • In order for one party to a voting agreement to be treated as having or sharing beneficial ownership of securities held by any other party to a voting agreement, evidence beyond formation of the group under Rule 13d-5(b) would need to exist. [105.06]
    • For example, if a party to a voting agreement has the right to designate one or more director nominees for whom the other parties have agreed to vote, the party with that designation right becomes a beneficial owner of the securities beneficially owned by the other parties, because the agreement gives that person the power to direct the voting of the other parties’ securities. [105.06]
    • Similarly, if a voting agreement confers the power to vote securities pursuant to a bona fide irrevocable proxy, the person to whom voting power has been granted becomes a beneficial owner of the securities under Rule Rule 13d-3. [105.06]
    • Conversely, parties that do not have or share the power to vote or direct the vote of other parties’ shares would not beneficially own such shares solely as a result of entering into a voting agreement. Note, however, that a contract, arrangement, understanding or relationship concerning voting or investment power among parties to the agreement, other than the voting agreement itself, may result in a party to the voting agreement having or sharing beneficial ownership of securities held by other parties to the voting agreement under Rule 13d-3. [105.06]
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The SEC’s Latest C&DIs Related to Bad Actor Disqualification

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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]

SEC Issues New C&DIs Related to Rules 506(c) and 144A

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Yesterday the Securities and Exchange Commission’s Division of Corporation Finance issued nine new Compliance and Disclosure Interpretations (C&DIs) related to the private offering exemption afforded by Rule 506(c) and two new C&DIs related to the private resale exemption afforded by Rule 144A.

The Rule 506(c) C&DIs in summary:

  • If, prior to the September 23, 2013 effective date of new Rule 506(c), an issuer commenced an offering in reliance on what was formerly Rule 506 (now Rule 506(b)), and that issuer now wishes to continue the same offering under Rule 506(c) (following the transition guidance in the final rules’ adopting release), then the issuer must file an amendment to its previously filed Form D and check the box indicating that is now relying on the exemption afforded by Rule 506(c). However, an issuer needn’t file a Form D amendment if it is simply continuing to rely on what was formerly Rule 506 (now Rule 506(b). [260.05]
  • If an issuer takes reasonable steps to verify that a purchaser is an accredited investor, and has a reasonable belief that such purchaser is an accredited investor at the time of the sale of its securities, but then later discovers that the purchaser did not meet the criteria for any category of accredited investor, the issuer will not lose its ability to rely on Rule 506(c) for the offering. [260.06]
  • If an issuer intends to conduct an offering under Rule 506(c) it must satisfy the reasonable steps to verify requirement even if all of the purchasers happen to be accredited investors; the verification requirement is separate from and independent of the requirement that sales be limited to accredited investors. [260.07]
  • If an issuer chooses to verify the accredited investor status of a purchaser using the non-exclusive net worth verification method and reviews the relevant documentation dated within the required prior three months, but by the time the purchaser decides to purchase securities in the offering the previously submitted documentation is no longer dated within the prior three months, then the issuer can not rely on the previously submitted documentation to satisfy the net worth verification method. The issuer may, however, determine it has taken reasonable steps to verify the purchaser’s accredited investor status under the principles-based method of verification. [260.08]
  • The  non-exclusive third-party verification method may be satisfied by written confirmation from an attorney or certified public accountant licensed or duly registered, as the case may be, in good standing in a foreign jurisdiction. [260.09]
  • The non-exclusive verification method for existing investors will not apply to new issuers that have the same sponsor as an issuer in which the investors purchased securities in a prior Rule 506(b) offering (e.g., a new limited partnership organized by a general partner where the investors purchased securities of a prior limited partnership sponsored by the same general partner). Rather the method is limited to verification of existing investors who purchased securities in the same issuer’s Rule 506(b) offering as accredited investors prior to September 23, 2013 and who continue to hold such securities. [260.10]
  • An issuer that commences an offering intending to rely on Rule 506(c) but does not engage in any form of general solicitation may subsequently rely on Rule 506(b) for the offering, provided the conditions of Rule 506(b) are satisfied with respect to all sales of securities that have occurred and the issuer amends any previously filed Form D to check the box indicating that it is now relying on the exemption afforded by Rule 506(b). [260.11]
  • Similarly, an issuer that commences an offering intending to rely on Rule 506(b) may subsequently rely on Rule 506(c) for the offering, provided the conditions of Rule 506(c) are satisfied with respect to all sales of securities in the offering and the issuer amends any previously filed Form D to check the box indicating that it is now relying on the exemption afforded by Rule 506(c). [260.12]
  • If the conditions of Rule 506(c) are not met in a purported Rule 506(c) offering and the issuer has engaged in general solicitation, then the issuer will not be able to claim the private offering exemption under Securities Act Section 4(a)(2). [260.13]

The Rule 144A C&DIs in summary:

  • In Rule 144A offerings in which securities are initially sold by an issuer to financial intermediaries in transactions exempt under Securities Act Section 4(a)(2) or Regulation S, the general solicitation may be conducted by the issuer as well as by the initial purchasers and other distribution participants. [138.03]
  • The amendments to Rule 144A permitting the use of general solicitation do not change how directed selling efforts under Regulation S are analyzed in concurrent Rule 144A and Regulation S offerings. [138.04]
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Yesterday, in an open meeting, the Securities and Exchange Commission voted unanimously to propose rules and forms to implement the crowdfunding exemptions established by Title III of the JOBS Act.

The proposing release is long, 585 pages long to be exact, with the text of the rules and forms taking up nearly 100 pages themselves, and, as per usual, comments are due 90 days after the release is published in the Federal Register.

In its press release announcing the proposed rules and forms, the Commission does offer some highlights of the major provisions, including those addressing:


  • An issuer that uses the crowdfunding exemption will be able to raise a maximum aggregate amount of $1 million dollars in a 12-month period. The proposing release itself further notes that capital raised through other means will not count towards the maximum aggregate amount sold in a crowdfunding offering, so an issuer that relies on the crowdfunding exemption may go on to raise additional capital in the same 12-month period using another exemption (assuming another exemption is available) and vice versa.
  • An issuer that uses the crowdfunding exemption will have to file certain offering information with the Commission and provide that information to its investors, potential investors and any crowdfunding intermediaries facilitating its offering. An issuer will also have to amend its offering information to reflect material changes and to provide updates about the offering’s progress. Among other things, offering documents will have to disclose:
    • officers, directors and owners of 20% or more of an issuer;
    • a description of the issuer’s business and the use of proceeds;
    • the price of the securities being offered;
    • the target offering amount and whether the issuer will accept investments in excess of the target offering amount;
    • certain related-party transactions;
    • a description of the financial condition of the issuer; and
    • financial statements of the issuer that, depending on the amount offered and sold during a 12-month period, will have to be accompanied by a copy of the issuer’s tax returns or reviewed by an independent public accountant or auditor.
  • An issuer that uses the crowdfunding exemption will also be required to file an annual report with the Commission and to provide copies to its investors.
  • The crowdfunding exemptions will not be available to:
    • foreign issuers;
    • Exchange Act reporting issuers;
    • certain investment companies, including private funds;
    • shell companies;
    • issuers that fail to comply with the proposed rules’ annual reporting requirements; and
    • issuers that are disqualified under the proposed rules’ disqualification provisions.


  • Securities purchased in a crowdfunding offering may not be transferred for a period of one year, unless they are transferred:
    • to the issuer;
    • to an accredited investor;
    • in a registered offering; or
    • to a family member in connection with certain events (such as in the case of death or a divorce).
  • Holders of securities issued in a crowdfunding offering will not count toward the threshold for Exchange Act registration under Section 12(g). The proposing release further notes that securities issued in a crowdfunding offering will be permanently exempt from Section 12(g) (even after being sold or otherwise transferred to a subsequent holder), however, the burden will be on the issuer to demonstrate that the securities were initially issued in a crowdfunding offering.


  • Over a 12-month period investors will be able to invest up to:
    • $2,000 or 5% of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000; or
    • 10% of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or greater than $100,000 (but only up to $100,000).


  • Crowdfunding offerings will be conducted exclusively online through a platform operated by a registered broker-dealer or funding portal.
  • Crowdfunding intermediaries will be required to:
    • provide investors with educational materials;
    • take measures to reduce the risk of fraud;
    • make information about the issuer and the offering available;
    • provide communication channels to permit discussions about offerings on the platform; and
    • facilitate the offer and sale of crowdfunded securities.
  • Crowdfunding funding portals (as distinct from broker-dealers) will be prohibited from:
    • offering investment advice or making recommendations;
    • soliciting purchases, sales or offers to buy securities offered or displayed on its website;
    • imposing certain restrictions on compensating people for solicitations; and
    • holding, possessing or handling investor funds or securities.

FINRA Proposes Funding Portal Rules and Forms

FINRA also announced the release a set of proposed funding portal rules and forms yesterday. The proposal considers comments received in response to FINRA’s initial request for comments on the regulation of crowdfunding activities and submissions from its interim form for funding portals.

Comments on FINRA’s release are due by February 3, 2014.

Update October 26, 2013

Comments on the proposed rules are already up …

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Various and Sundry From the Week That Was

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GAO’s Accredited Investor Study

Section 415 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires that the Government Accountability Office “conduct a study on the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds … ” by the third anniversary of the Act’s enactment (or July 21, 2013; it’s sometimes hard to believe that it’s been three years already).

GAO released the results of its study on Thursday, concluding and entitling the report: Alternative Criteria for Qualifying As An Accredited Investor Should Be Considered.

The report recommends eight alternative criteria grouped into two main categories.

Category I – Financial Resources 

    • Liquid investments requirement. Investors would have to have a minimum dollar amount of investment in liquid assets (that is, assets that can be easily sold, are marketable, and the value of which can be verified by a financial institution).
    • Fixed-percentage investment. Investors would be limited in their investments in single, nonpublic securities offerings to a certain percentage of their individual net worth or income.

Category II – Understanding of Financial Risk

    • Licenses/certification. Investors would have to demonstrate knowledge of financial risks related to private placement investments to receive licenses from regulators or authorized third parties.
    • Investor sophistication test. Investors would complete SEC-approved investor education classes and pass a test that would qualify them as accredited.
    • Self-certifying as a sophisticated investor. Investors would self-certify based on standards such as membership in a network of investment groups, work experience, or investment experience.
    • Education. Investors would qualify as accredited based on an advanced degree in business or finance, a chartered financial analyst credential, or similar designation.
    • Opt-in provision. Investors would sign a statement that waives significant rights to file a complaint or seek compensation unless there is fraud on the part of the issuer.
    • Registered investment adviser requirement. Investors who wished to invest in private placement offerings would have to use the services of registered investment advisers to manage their investment accounts.

The Commission, in its comments to the report, noted that the staff will factor in the GAO’s recommendations when conducting its own review of the definition of accredited investor in 2014 (as mandated by Section 413 of the Dodd-Frank Act). In particular, the Commission will consider the GAO’s recommendations related to liquid investment requirements and registered investment advisor requirements.

Disclosure Guidance Regarding Non-Traded REITs

On Tuesday the Division of Corporation Finance issued disclosure guidance summarizing the staff’s observations in its review of Securities Act and Exchange Act filings of non-traded real estate investment trusts (REITs).

Commissioner Nominees

On Thursday the Senate Banking Committee unanimously voted to confirm Commissioner nominees Kara M. Stein (Democrat), currently Legal Counsel and Senior Policy Advisor to Senator Jack Reed, and Dr. Michael Piwowar (Republican), currently the Chief Economist for the Senate Banking Committee, as replacements for Commissioners Walter and Paredes. The next order of business is confirmation by the full Senate, which Reuters notes should be non-controversial.

The Committee also voted to confirm Chairman White for a full five-year term.

Cyber Crime and Securities Exchanges

According to a report released by the International Organization of Securities Commissions and World Federation of Exchanges on Tuesday, over half of 46 securities exchanges surveyed by OICU-IOSCO and WFE have experienced a cyber attack last year.

The most common and most disruptive attacks being denial-of-service attacks and malicious software (viruses).

Exchange Reported Cyber Attacks

Working at the SEC

Finally, it doesn’t look like the Commission will be receiving any workplace recognition awards this year, coming in 19th out of 22 among similarly sized federal agencies in a GAO a survey on employee satisfaction and commitment (see also Reuters).

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