Bad Actor Rule for Fund Managers
Rule 506(d) disqualifies an offering from Regulation D Rule 506 if the issuer or a covered person has had a disqualifying event, such as a securities fraud conviction, a court injunction, certain regulatory orders or a disciplinary history. For a fund, covered persons include the fund, its general partner or manager, directors and executive officers, 20 percent owners and anyone paid to solicit investors. Managers collect questionnaires and keep records of their reasonable care.
Who is a covered person
- The issuer, including the fund and its predecessors and affiliated issuers
- Directors, executive officers and other officers who participate in the offering
- General partners and managing members
- Beneficial owners of 20 percent or more of the issuer's voting equity
- Promoters connected with the issuer
- Investment managers of pooled funds, and the managers' directors and officers
- People paid to solicit investors, and their directors and officers
What disqualifies
| Category | Examples |
|---|---|
| Criminal convictions | Felony or misdemeanor convictions connected with securities, within lookback periods |
| Court orders | Injunctions relating to securities activities |
| Regulatory orders | Certain state, federal and banking regulator orders |
| SEC disciplinary orders | Suspensions, bars and cease-and-desist orders |
| Self-regulatory organization expulsions | Suspension or expulsion from a securities association |
| Stop orders and false filing sanctions | Orders relating to registration statements |
Lookback and disclosure
Each event has its own lookback period, commonly five or ten years from the event, with some depending on the date of the order or end of a sentence. Events that occurred before September 2013 do not disqualify, but they must be disclosed to investors under Rule 506(e). A waiver may be available from the SEC in some cases, but it must be granted before the offering relies on the exemption.
How managers handle it
- Identify every covered person at the start and update the list as the team changes.
- Send each person a questionnaire asking about disqualifying events and ask them to update if anything changes.
- Check public records and databases as part of reasonable care, and keep the results.
- Update the questionnaires at least before each new closing or offering.
- Disclose pre-2013 events as the rule requires.
Why it matters
A single disqualified person can destroy the exemption for the entire offering, which could mean investors have rescission rights and regulators may act. The reasonable care exception can protect a sponsor who did not know of a hidden event, but only if it can show it asked. See the rule 506(d) overview and subscription agreements and questionnaires.
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Book Free ConsultationFrequently asked questions
Does the bad actor rule apply to investors?
Only to investors who own 20 percent or more of the voting equity, or who otherwise fit a covered category.
How often should questionnaires be updated?
At least before each closing, and whenever the team or ownership changes.
Can a disqualified person still be involved?
Not in a covered role, unless there is a waiver or the person is removed.
Is the rule the same for 506(b) and 506(c)?
Yes. It applies to both, and Rule 504 has its own version.