As we have noted, the SEC has proposed rules under Section 926 of the Dodd-Frank Act to disqualify offerings involving felons and other “bad actors” and associated persons from relying on Rule 506 of Regulation D in private placements. The proposed rules will force issuers to make difficult judgments as to whether or not their offering will qualify for an exemption under Rule 506.
The SEC has sought to minimize the impact of the rules. The proposed rule would provide an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed. But how much protection does that really provide?
For instance, a 10% beneficial owner who has committed a disqualifying event will preclude the issuer from relying on Rule 506. So a careful issuer might send all 10% owners a questionnaire to complete. But what if the owner will not return it? Has the issuer exercised reasonable care and can it proceed?
Broker-dealers and others who receive compensation from an offering can also preclude reliance on Rule 506 if they have been subject to a disqualifying event. Practice may develop where the placement agents make representations to the issuer that no disqualifying events have occurred. Can an issuer rely on those representations? Or must it check FINRA, SEC and other data bases as well?
And must issuers headed toward an IPO even be more careful? What if the underwriters look under rock the issuer has not turned over during due diligence and find something?
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