On May 25, 2011, the Securities and Exchange Commission (SEC) proposed a rule that would, among other things, prevent an issuer from using a Rule 506 exemption for any securities offerings in which “felons and other ‘bad actors’” are involved. The current version of Rule 506 does not impose any bad-actor disqualification requirements.

Rule 506, which is the most widely used exemption from registration under the securities laws (accounting for an estimated 90-95 percent of the offerings made under Regulation D), allows an issuer to raise unlimited capital from an unlimited number of accredited investors, provided that certain conditions are met. The proposed rule implements the provisions of Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), which is proposed to be codified in a new paragraph (c) of Rule 506. The Dodd- Frank Act requires the new rule to be “substantially similar” to the bad-actor disqualification provisions of Rule 262 of Regulation A, which is an exemption from registration for certain small offerings, and to include an expanded list of disqualifying events enumerated in the Dodd-Frank Act.

Once the SEC’s proposed rule takes effect, an issuer hoping to rely on a Rule 506 exemption will need to conduct a factual inquiry with respect to potentially disqualifying events to establish its reasonable care exception.