The SEC’s Division of Corporate Finance (the Division) has recently issued new guidance (in the form of “Frequently Asked Questions”) to clarify what constitutes a “beneficial owner” for the purposes of Rule 506(d) of the Securities Act (the Bad Actor Rule). Generally, the Bad Actor Rule disqualifies issuers from relying on the exemptions set forth in Rule 506 of the Securities Act if such issuers have “covered persons” who have engaged in certain “disqualifying events.” “Covered persons” includes 20% beneficial owners of the issuer for purposes of the Bad Actor Rule. 

Consistent with its informal oral guidance the Division had been providing to the industry, the Division clarified that for purposes of the Bad Actor Rules, a “beneficial owner” is interpreted the same way as under Rule 13d-3 of the Securities Exchange Act of 1934 (as amended, the Exchange Act). Therefore, a “beneficial owner” generally includes any person who, directly or indirectly (through any contract, arrangement, understanding or otherwise) has or shares, or is deemed to have or share (i) voting power (including the power to vote or direct the vote of such security) and/or (ii) investment power (including the power to dispose or to direct the disposition of such security). As a result, even larger limited partners may not be “beneficial owners” for purposes of the Bad Actor Rules if they don’t have the power to vote or investment power.

In its guidance, the Division further concluded that the disclosure obligations in Rule 506(e) requiring issuers to disclose to investors any disqualifying events that occurred prior to September 23, 2013 are not waived by the procedures in Rule 506(d)(2)(iii). Rule 506(d)(2)(iii) generally allows issuers to avoid disqualification by delivering an order of a regulator or court advising the SEC that a Rule 506 disqualification should not occur because the disqualifying event occurred on or after September 23, 2013. Thus, while a disqualification can be lifted by such an order, the obligation to disclose such disqualification remains.

In light of the clarifying guidance, firms should require all appropriate covered persons complete their “Bad Actor Questionnaires” and ensure any appropriate disclosures are made with respect to any disqualifying event occurring prior to September 23, 2013.