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SEC Finalizes “Bad Actor” Rules

On July 10, 2013, the SEC adopted a new set of rules preventing certain “Bad Actors” from participating in private placement offerings under Rule 506 of the Securities Act of 1933, as amended (the “Securities Act”).[1] Under new Securities Act Rule 506(d), an issuer will be unable to rely on a Rule 506 exemption if the issuer or any of its “covered persons” had a “disqualifying event.” These rules are effective as of September 23, 2013 (the “Effective Date”).

For purposes of Rule 506(d), a “covered person” of the issuer includes:

  1. any predecessor or affiliate of the issuer;
  2. any director, officer[2], general partner or managing member of the issuer;
  3. any investment manager (and principals of such investment manager) of an issuer that is a pooled investment fund;
  4. any promoter connected with the issuer in any capacity at the time of sale;
  5. any twenty percent (20%) beneficial owner (based on voting power) of the issuer; and
  6. any “compensated solicitor,” which is defined as a person that has been or will be (directly or indirectly) paid for the solicitation of purchasers in connection with sales of securities in the offering, and any director, officer, general partner or managing member of such compensated solicitor.

Under the new rule, a “disqualifying event” pertaining to the issuer or one of its “covered persons” includes any of the following:

  1. a criminal conviction, court injunction or restraining order (a) in connection with the purchase or sale of a security, (b) in connection with making a false filing with the SEC, or (c) arising out of the conduct of certain financial intermediaries;
  2. certain SEC orders, including:
    • disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies, and investment advisers and their associated persons;
    • cease-and-desist orders related to violations of certain anti-fraud provisions and registration requirements of the federal securities laws; and
    • stop orders and orders suspending the Regulation A exemption issued within five (5) years of the proposed sale of securities.
  3. final orders from the CFTC and certain other federal or state regulators of securities, insurance, banking, savings associations or credit unions that (a) bar the issuer from associating with a regulated entity, engaging in the business of securities, insurance or banking, or engaging in savings association or credit union activities, or (b) are based on fraudulent, manipulative or deceptive conduct and are issued within ten (10) years of the proposed sale of securities;
  4. suspension or expulsion from membership in a self-regulatory organization (“SRO”) or from association with an SRO member; and
  5. U.S. Postal Service false representation orders issued within five (5) years before the proposed sale of securities.

The SEC staff set forth a “reasonable care” exception to the Bad Actor disqualification in respect of Rule 506 offerings. Pursuant to this exception, an issuer will not be barred under the Bad Actor disqualification if it can show that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering. This “reasonable care” analysis will vary based on the specific facts and circumstances for each issuer, offering and the offering’s participants in question.

The Bad Actor disqualification will apply only for disqualifying events that take place after the Effective Date. However, any matters deemed to be “disqualifying events” that existed prior to the Effective Date must be disclosed to investors in written form within a reasonable time prior to any sale.

Private fund advisers relying on Rule 506 for their offerings should ensure that they do not have a relationship with any covered persons who are deemed to be Bad Actors. Advisers should consider circulating a questionnaire to assist them in making this determination. Please let us know if you would like a questionnaire to distribute.


[1] See Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings, SEC Rel. No. 33-9414, Jul. 10, 2013.

[2] For purposes of Rule 506(d), an officer means any executive officer or other officer who participated in the offering.


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09.04.2013  |  PUBLICATION: BulletPoint  |  TOPICS: Investment Management, Securities

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