On May 25, 2011, to implement the requirements of Section 926 of the Dodd-Frank Act, the SEC issued proposed amendments to Rules 501 and 506 and Form D that disqualify securities offerings involving certain felons and other bad actors from reliance on the safe harbor from registration under Section 4(2) of the Securities Act. Section 926 of the Dodd-Frank Act was designed to combat concerns that felons and other bad actors could utilize the registration exemptions provided by rules such as Rule 506 to perpetrate securities fraud.
The proposed amendments would apply to the following "covered persons":
- the issuer and any predecessor of the issuer or affiliated issuer
- any director, officer, general partner or managing member of the issuer
- any beneficial owner of 10% or more of any class of the issuer's equity securities
- any promoter connected with the issuer in any capacity at the time of the sale
- any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering
- any director, officer, general partner or managing member of any such compensated solicitor
The proposed amendments would disqualify offerings from Rule 506 if any covered person participating in the offering had any of the following "disqualifying events":
- criminal convictions in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries; the criminal conviction must have occurred within 10 years of the proposed sale of securities, or five years, in the case of the issuer
- court injunctions and restraining orders in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries; the injunction or restraining order must have occurred within five years of the proposed sale of securities
- final orders from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from (i) associating with a regulated entity, (ii) engaging in the business of securities, insurance or banking, (iii) engaging in savings association or credit union activities, or orders that are based on fraudulent, manipulative or deceptive conduct and are issued within 10 years before the proposed sale of securities
- certain SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons, which would be disqualifying for as long as the order is in effect
- suspension or expulsion from membership in a "self-regulatory organization" or from association with an SRO member, which would be disqualifying for the period of suspension or expulsion
- SEC stop orders and orders suspending the Regulation A exemption issued within five years before the proposed sale of securities
- U.S. Postal Service false representation orders issued within five years before the proposed sale of securities
The proposed amendments also provide for a "reasonable care" exception, under which an issuer would not lose the benefit of the Rule 506 safe harbor, despite the existence of a disqualifying event, if it can show that it did not know and, in the exercise of reasonable care, could not have known of the existence of the disqualification. An issuer would be expected to conduct a factual inquiry, the nature and extent of which would depend on the facts and circumstances of the situation, to be able to establish that it acted with reasonable care. In addition, the proposed amendments would permit an issuer to seek waivers from disqualification under Rule 506 by direct order of the SEC itself (and not staff).
The proposed amendments would apply to all sales of securities that take place after the effective date of the final rules based on all disqualifying events that have occurred within the specified time periods, which would include events that occurred before the enactment of the Dodd-Frank Act or the effectiveness of the final amendments to the rules. The SEC seeks public comments to the proposed amendments, which must be received on or before July 14, 2011.