Pursuant to a Securities and Exchange Commission ("SEC") rule change that took effect on September 23, 2013, the exemption from registration provided by Rule 506 of Regulation D is unavailable for all offerings of securities that have a felon or other “bad actor” involved in the offering. The disqualification provisions apply to offerings using both general solicitation and advertising allowed under the SEC’s newly adopted Rule 506(c) (also effective as of September 23, 2013) and offerings not using general solicitation or advertising under existing Rule 506(b).
In order to determine eligibility to conduct an unregistered offering of securities under Rule 506, issuers will need to conduct an investigation regarding whether any “covered persons” have been involved in any disqualifying events. “Covered persons” include: (i) the issuer and any predecessor or affiliated issuer; (ii) any director, executive officer or other officer participating in the offering, general partner or managing member (each a “Controlling Person”) of the issuer; (iii) any beneficial owner of 20% or more of the issuer’s outstanding voting securities; (iv) any investment manager to an issuer that is a pooled investment fund and any Controlling Person of such investment manager; (v) any promoter connected with the issuer at the time of sale; and (vi) any person who receives direct or indirect compensation for solicitation of purchasers in the offering and any Controlling Person of such solicitor. Under the new rule, examples of disqualifying events include:
- Being convicted within 10 years prior to the sale (five years for the issuer or its predecessor or affiliated issuers) of any felony or misdemeanor relating to the securities industry or making false filings with the SEC;
- Being the subject of a final order of a court or various state and federal regulators, including banking regulators and the SEC, that bars the covered person from engaging in the securities, insurance or banking industries, or relates to claims of fraudulence, manipulation or deception, among other things;
- Filing or being named as an underwriter in any registration statement that was the subject of a stop order from the SEC within five years before the sale; orBeing subject to a U.S. Postal Service false representation order.
Offerings are exempt from disqualification if the events in question took place prior to September 23, 2013. However, such pre-existing events must be disclosed to all investors in the offering in a reasonable time prior to the sale of the securities.
There is also an exception from disqualification if the issuer can establish that it did not know and, in the exercise of reasonable care, could not have known about a disqualifying event. The SEC has indicated that reasonable care can be demonstrated by having covered persons complete a questionnaire and provide representations, warranties and undertakings in subscription documents and placement agreements stating that they have not been subject to any disqualifying events.