Rule 506(d) Bad Actor Disqualification
Rule 506(d) disqualifies an offering from Rule 506 if the issuer or a covered person, such as an officer, director, 20 percent owner or paid solicitor, has had a disqualifying event, including certain criminal convictions, court injunctions, regulatory orders and disciplinary actions within set lookback periods. An issuer that did not know and exercised reasonable care to find out can avoid disqualification, which is why sponsors collect questionnaires and document their diligence.
Covered persons
The rule applies to the issuer and its predecessors and affiliated issuers, directors, executive officers and officers who participate in the offering, general partners and managing members, 20 percent beneficial owners of voting equity, promoters, investment managers of pooled funds and people paid to solicit investors, along with the directors and officers of those who are entities. The list is broad, so identify everyone before the offering starts.
Disqualifying events
| Event | Lookback, in general |
|---|---|
| Criminal convictions in connection with securities or false filings | Five years for the issuer and its predecessors, ten years for other covered persons |
| Court injunctions related to securities | Five years |
| Final orders of state securities, banking or insurance regulators | Ten years for certain orders based on fraud, five years for others, or while a bar remains in effect |
| SEC disciplinary orders and cease-and-desist orders | Five years for cease-and-desist orders, while in effect for suspensions and bars |
| Suspension or expulsion from a self-regulatory organization | While in effect |
| SEC stop orders and Regulation A suspensions | Five years |
The exact periods and triggers are technical, so counsel should review any history.
Reasonable care
The issuer is not disqualified if it can establish that it did not know, and in the exercise of reasonable care could not have known, that a disqualification existed. Reasonable care generally means asking each covered person to complete a questionnaire, checking public databases and updating periodically. Documentation is the evidence. Without a record, the defense is hard to prove.
Disclosure and waivers
- Pre-2013 events. Events that happened before September 23, 2013 do not disqualify but must be disclosed to investors under Rule 506(e).
- Waivers. The SEC can waive disqualification for good cause, and a waiver should be obtained before relying on Rule 506.
- State laws. Some states have their own bad actor rules that affect notice filings.
Practical steps
- Build a covered persons list for each offering.
- Distribute and collect bad actor questionnaires before opening the offering.
- Run searches and keep the results.
- Refresh before each new closing and when ownership changes.
- Include a bad actor representation in agreements with finders and placement agents, if any are used.
See the bad actor rule for fund managers and Form D.
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Book Free ConsultationFrequently asked questions
Does the rule apply to Rule 504 and 506(c) too?
Rule 506(d) applies to Rule 506(b) and 506(c). Rule 504 has a parallel provision.
Is an investor ever a covered person?
Only a 20 percent or greater holder of voting equity of the issuer is.
Can I still raise money if someone is disqualified?
You must remove the person from a covered role, obtain a waiver or use another exemption.
What if a person does not answer the questionnaire?
Treat them as a problem. Without a response, you may not be able to show reasonable care.