This month, the Division of Corporation Finance of the U.S. Securities and Exchange Commission issued new interpretations in its Compliance and Disclosure Interpretations (“C&DIs”) regarding Rule 506(d) and (e) of Regulation D under the Securities Act of 1933. Under Rule 506(d), issuers cannot rely on the 506 private placement safe harbor if any “covered person” associated with the offering has been involved in any “disqualifying event.”
A handful of items that are of particular interest to private investment funds and their advisers are highlighted below. The full list of interpretations is provided in questions 260.14 to 260.26, which can be accessed here.
- Only a fund that is offering or selling securities needs to determine if it is subject to the bad actor disqualification. A fund closed to new investments or winding down does not need to make this determination.
- A fund may rely on a covered person’s agreement to provide notice of a triggering event pursuant to a contractual covenant, questionnaire, certification or bylaw requirement. Note that if an offering is continuous, delayed or long-lived, a fund is required to periodically update its factual inquiry through bring-downs, questionnaires, certifications, negative consent letters, rechecking public databases or other steps depending on the circumstances. The SEC did not give any additional guidance or provide a safe harbor on the frequency of this inquiry.
- An affiliated issuer of a fund is an affiliate that is issuing securities in the same offering. A fund should consider the integration rules under Rule 502(a) when determining if it has any affiliated issuers.
- Convictions, court orders and injunctions by a foreign court or regulatory orders by foreign regulatory authorities are not disqualifying events.
- The reasonable care exception applies if a fund establishes that it did not know and, despite exercising reasonable care, could not have known that a disqualification event existed or that a particular person was a covered person or that it initially determined that a person was not a covered person and later learned that its determination was incorrect. A fund needs to consider what steps are appropriate upon discovery of a disqualifying event or covered person during on ongoing offering.
- With regard to solicitors:
- All persons who receive or will receive compensation, either directly or indirectly, for soliciting investors are covered persons under Rule 506(d), regardless of whether such persons are required to register as broker-dealers or associated persons of a broker-dealer.
- If a placement agent or one of its covered control persons becomes subject to a disqualifying event during a continuous offering, a fund can continue to rely on Rule 506 if the engagement with the placement agent is terminated and the placement agent does not receive compensation for future sales. If the disqualifying event affects only covered control persons of the placement agent, a fund can continue to rely on Rule 506 if such persons are terminated or no longer perform roles that would cause them to be covered persons under Rule 506(d).
- Participation in an offering is not limited to soliciting investors but extends to activities such as involvement with due diligence, preparation of offering materials, providing structuring or other advice to a fund in connection with the offering and communicating with the fund, prospective investors or other offering participants about the offering. The SEC did provide that such activities must be more than transitory or incidental and that administrative functions or serving on a transaction committee to approve a solicitor’s participation in an offering would not be deemed to be participating in an offering.
- A fund must disclose all bad acts for all solicitors that occurred prior to September 23, 2013, not just the solicitor for a particular investor. Disclosures do not need to be provided for solicitors no longer involved with an offering.