I’ve devoted several recent posts to the Securities and Exchange Commission’s new “bad actor” rule because it is awash with a sea of troubles for issuers, both private and publicly traded. The rule prevents issuers from relying on Rule 506 if they are or have been subject to any of a long list of disqualifying events. The rule, however, also punishes issuers for the sins of others, including persons with whom they may be unable to disassociate (e.g., directors and beneficial owners of 20% or more of the issuer’s voting securities). The consequences, moreover, can be severe – impacting the ability to rely on Rule 506 to effect private placements, engage in acquisitions, and conduct Rule 144A or PIPE offerings. This has led me to ponder whether some issuers will include a “bad actor” risk factor.
Here’s one reason why a “bad actor” risk factor shouldn’t be necessary, or even appropriate, for most companies. Item 503(c) of Regulation S-K quite clearly provides:
Do not present risks that could apply to any issuer or any offering.
If an issuer decides to include a “bad actor” risk factor, it should be prepared to explain how the disqualification applies to itself, its industry or offering.
The Commissioner of Corporations Who Midwifed California’s Nascent Aerospace Industry
In 1925, man had been building an successfully flying airplanes for more than two decades. Yet the Department of Corporations was skeptical and took a negative position with respect to securities application of air transportation companies. Commissioner J. M. Friedlander reversed that policy, writing:
I feel that aerial transportation and the manufacture of equipment for such transportation should be regarded in a common sense way. . . . Whether or not aerial transportation has proved successful, there is no doubt it has reached a point where it must be regarded as legitimate and worthy of encouragement. The department so regards it.
Biennial Report of the State Corporation Department, October 31, 1928. Commissioner’s enlightened attitude to aeronautics was particularly fortunate for California. At the time, California was competing with Michigan, New York, Illinois and several other states as a home for the new industry. According to the Los Angeles County Economic Development Corporation, Southern California would at the height of the Cold War become home to 15 of the 25 largest aerospace companies in the United States.
Unfortunately, the future for Commissioner Friedlander did not prove to be as sunny as for the industry that he green lighted. He was indicted, but never tried, and died young.