"Bad Actor" Disqualification from Rule 506 Offerings


On May 27, 2011, the Securities and Exchange Commission, as required under the Dodd-Frank Wall Street Reform and Consumer Protection Act, released a proposed rule1 which would disqualify an entity from using the Rule 506 private offering safe harbor if the entity or a “covered person” associated with the entity is or had been involved in a “disqualifying event,” specified violations of securities laws or the regulations of securities administrators or certain related entities.

Although currently only a proposed rule, the revisions are significant, as Rule 506 is by far the most widely used SEC-sanctioned securities offering exemption and one of the most cost-efficient ways for small businesses to raise equity capital. For a non-public issuer with a current or future need to raise equity capital in excess of $1,000,000, an inability to use Rule 506 could very well imperil that issuer’s future. Additionally, if an offering thought to be exempt under Rule 506 turns out not to be due to “bad actor” disqualification, the issuer could face action from either the SEC or its investors.

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