Will Issuers Add Rule 506(d) Bad Acts To The Definition Of “Cause”?

The SEC’s new bad actor rule, Rule 506(d), may cause some issuers to consider expanding the definition of “cause” in their employment agreements with executive officers.  Because executive employment agreements typically reduce severance payments significantly in the case of “for cause” terminations, the definition of “cause” is often hotly negotiated.

While “cause” definitions often include conviction of a felony or a felony involving moral turpitude, I’ve never seen a definition of “cause” that includes all of the disqualification provisions in Rule 506(d).  This can have real consequences for companies who may face the difficult choice of foregoing reliance on Rule 506 or terminating an executive officer without cause and making a large severance payment.  This won’t be a problem for the small or closely held company.  Large, SEC reporting companies also rely on Rule 506 in connection with Rule 144A and PIPE (Private Investment in Public Equity) offerings.

Issuers may also want to take a look at the “cause” definitions in their equity compensation and other employee benefit plans.  While awards and benefits under these plans are typically available to a wide range of employees, executive officers and other covered persons under Rule 506(d) will likely hold awards under these plans.

From the executive’s perspective, broadening the definition of “cause” will make employment and compensation far more risky.  Thus, they can be expected to resist more expansive definitions.  Alternatively, they may insist on higher compensation to offset the increased uncertainty.