SEC Staff Issues New Guidance on Rule 506 Bad Actor Disqualification

The staff of the SEC’s Division of Corporation Finance posted additional Compliance and Disclosure Interpretations  (see Questions 260.14 through 260.27) to the SEC website that address the “bad actor” disqualification provisions of the Rule 506 private offering exemption under the Securities Act of 1933 (the “Guidance”).  In broad terms, the bad actor disqualification provisions of Rule 506, which fulfill a mandate under the Dodd-Frank Act, disqualify an offering of securities from the Rule 506 exemption if any of certain categories of persons involved in, or related to, the offering (“covered persons”) is subject to a “disqualifying event” that occurs on or after September 23, 2013, or the issuer fails to appropriately disclose to investors any disqualifying event that occurred prior to that date, subject in each case to a “reasonable care” exception.  Bad actor disqualification is discussed in greater detail in the July 23, 2013 Financial Services Alert

This article summarizes some of the principal areas addressed in the  Guidance.  Other topics covered in the Guidance include the compensated solicitor category of “covered persons,” appropriate steps following discovery of disqualifying events and additional covered persons during an ongoing Rule 506 offering, and the scope of disqualification triggered by SEC orders to cease and desist from violations of SEC rules promulgated under Section 10(b) of the Securities and Exchange Act of 1934.

Affiliated Issuer.  The Guidance clarifies that the “affiliated issuer” category of covered persons does not refer to every affiliate of the issuer that has issued securities.  Instead, the term is limited to any affiliate (as defined in Rule 501(b) to be any 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.   The Guidance notes that offerings subject to integration under Rule 502(a) of Regulation D are part of the same offering for this purpose and refers to Securities Act Forms C&DIs Questions 130.01 and 130.02) as examples of co-issuer or multiple issuer offerings.

No Disqualifying Events under Non-U.S. Authority.  Bad actor disqualification is not triggered by actions taken in jurisdictions other than the United States, such as convictions, court orders, or injunctions in a foreign court, or regulatory orders issued by foreign regulatory authorities.

Disclosure Regarding Multiple Placement Agents.  The obligation to provide disclosure about pre-September 23, 2013 bad acts by placements agents requires disclosure to each investor regarding all placement agents involved with the offering at the time of sale (and their related persons), not just with respect to the particular placement agent that solicited the investor.  No disclosure is required with respect to placement agents no longer involved with the offering.

No Waiver of Disclosure Obligation.  The Guidance states that Rule 506(e) does not provide a procedure for an issuer to seek a waiver with respect to the obligation to disclose pre-September 23, 2013 disqualifying events.

Covered Person Due Diligence.  An issuer may reasonably rely on “a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to, for example, contractual covenants, bylaw requirements, or an undertaking in a questionnaire or certification.”  For an offering that is continuous, delayed or long-lived, the Guidance provides that periodic updates are required and may be accomplished through “bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.”

Covered Person Determinations -  Reasonable Care Exception.  The Guidance clarifies that, in addition to due diligence regarding the existence of disqualifying events, the reasonable care exception also applies to situations where an issuer 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.”

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.