On December 4, 2013, the Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) issued Compliance and Disclosure Interpretations (“CDIs")1 addressing several questions that may arise regarding the recently adopted “bad actor” disqualification provisions applicable to offerings relying on Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”). The SEC issued some guidance regarding the “bad actor” provisions on September 19, 2013, but the new CDIs are more helpful, and, in particular, with respect to the scope of the term “affiliated issuers” (discussed below), indicate an important reconsideration by the SEC.
As background, Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to adopt rules to disqualify certain securities offerings from reliance on Rule 506 in a form substantially similar to the bad actor disqualification provisions contained in Rule 262 of Regulation A, but with an expanded list of disqualifying events. The provisions were adopted as Rules 506(d) and 506(e) of Regulation D under the Securities Act.2
The disqualification provisions apply to certain covered persons, including any “affiliated issuer” of the issuer engaged in the offering. The phrase “affiliated issuer” has raised concern due to its potentially broad reach. However, in a significant limiting interpretation, the SEC narrowed its scope as follows:
Question: For purposes of Rule 506(d), does an “affiliated issuer” mean every affiliate of the issuer that has issued securities?
Answer: No. Under Rule 506(d), an “affiliated issuer” of the issuer is an affiliate (as defined in Rule 501(b) of Regulation D) of the issuer that is issuing securities in the same offering, including offerings subject to integration pursuant to Rule 502(a) of Regulation D. Securities Act Forms CDIs 130.01 and 130.02 provide examples of co-issuer or multiple issuer offerings. [Dec. 4, 2013]
While some interpretive questions regarding the phrase “affiliated issuer” may still arise, this CDI is very helpful as it clarifies that investment funds engaged in offerings under Rule 506 that are affiliated with large financial institutions are not required to treat as “affiliated issuers” other affiliates of the financial institution unless the affiliate is issuing securities in the same offering (including integrated offerings) as the investment fund.
The CDIs stated that a disqualifying event that occurs during the course of an offering will not prevent reliance on Rule 506 if certain conditions are satisfied:
Question: If a placement agent or one of its covered control persons, such as an executive officer or managing member, becomes subject to a disqualifying event while an offering is still ongoing, could the issuer continue to rely on Rule 506 for that offering?
Answer: Yes, the issuer could rely on Rule 506 for future sales in that offering if the engagement with the placement agent was terminated and the placement agent did not receive compensation for the future sales. Alternatively, if the triggering disqualifying event affected only the covered control persons of the placement agent, the issuer could continue to rely on Rule 506 for that offering if such persons were terminated or no longer performed roles with respect to the placement agent that would cause them to be covered persons for purposes of Rule 506(d). [Dec. 4, 2013]
The CDIs clarified that when multiple solicitors are involved in an offering, the disclosure obligations of each apply to all solicitors in the offering:
Question: In an offering in which the issuer uses multiple placement agents or other compensated solicitors, is the issuer required to provide investors with disclosure under Rule 506(e) only with respect to the particular compensated solicitor or placement agent that solicited those investors and its covered control persons (i.e., general partners, managing members, directors, executive officers, and other officers participating in the offering)?
Answer: No. Issuers are required to provide all investors with the Rule 506(e) disclosure for all compensated solicitors who are involved with the offering at the time of sale and their covered control persons. [Dec. 4, 2013]
The CDIs also clarified that, in a continuous offering, once a solicitor’s role in the offering is completed, the disclosure requirements as to that solicitor no longer apply:
Question: In a continuous offering, is the issuer required to provide disclosure under Rule 506(e) for all solicitors that were ever involved during the course of the offering?
Answer: No. For a reasonable time prior to the sale of securities in reliance on Rule 506, the issuer must provide the required disclosure with respect to all compensated solicitors that are involved at the time of sale. Disclosure with respect to compensated solicitors who are no longer involved with the offering need not be provided under Rule 506(e) in order for the issuer to be able to rely on Rule 506. [Dec. 4, 2013]
Other issues addressed include the timing of when an issuer must determine whether a disqualifying event has occurred (any time they are offering or selling securities in reliance on Rule 506) and the scope of the activities that involve “participating” in the offering (not limited to solicitation).
The most significant interpretation issued by the SEC is the narrowing of the term “affiliated issuer” since this interpretation will greatly limit the scope of the disqualifying provisions to issuers and simplify the disclosure and compliance requirements that would have applied under a broader reading of the term.