On December 4, 2013, the SEC's the Division of Corporation
Finance issued additional Compliance and Disclosure Interpretations
(the Guidance) on certain aspects of the
"bad actor" rules under the Securities Act of 1933 that
became effective on September 23, 2013. As described in our
previous client alert on this topic, the new rules disqualify
certain persons (known as "Covered Persons") who have
been the subject of specific disqualifying events from being
involved in Reg D private offerings relying on Rule 506. That alert
can be accessed by
clicking here. The new Guidance clarifies the following aspects
of Rules 506(d) and 506(e):
Reasonable Care. Issuers must determine with
reasonable care if they are subject to bad actor disqualification
any time they are offering or selling securities in reliance on the
Rule 506 exemption from Securities Act registration. The Guidance
clarifies that if an issuer is not offering securities, such as a
fund that is winding down and is closed to investment, it need not
determine whether Rule 506(d) applies unless and until it commences
a Rule 506 offering. Instead, the issuer may rely on a Covered
Person's agreement to provide notice of a potential or actual
bad actor triggering event. If, however, an offering is ongoing,
the issuer must periodically update its inquiry by, for example,
bring-down representations, questionnaires, certifications,
negative consents, checking public databases and other steps
depending on the circumstances.
Rule 506(d) provides that if an issuer can establish that it did
not know, and in the exercise of reasonable care, could not have
known that a bad actor disqualification existed, the issuer will
not be subject to disqualification. The Guidance makes clear that
this exception applies when, despite the exercise of reasonable
care, the issuer (a) was unable to determine the existence of a
disqualifying event, or that a particular person was a Covered
Person, or (b) initially reasonably determined that the person was
not a Covered Person but subsequently learned that determination
was incorrect. The Guidance notes that issuers will still need to
consider what steps are appropriate upon discovery of a
disqualifying event or Covered Persons during the course of an
ongoing offering. The Guidance states that an issuer may need to
seek waivers of disqualification, terminate the relationship with
Covered Persons, provide Rule 506(e) bad actor disclosure or take
other remedial steps that address the disqualification.
Bad Actors: Affiliated Issuers, Placement Agents and
Solicitors. The Guidance addresses the bad actor status of
affiliated issuers, placement agents and solicitors.
The Guidance clarifies that an "affiliated issuer" of an
issuer for purposes of bad actor disqualification and due diligence
includes only affiliates of the issuer that are issuing securities
in the same offering, including offerings subject to integration
pursuant to Rule 502(a).
With respect to placement agents, an issuer can continue to rely
on the Rule 506 exemption from Securities Act registration for
future sales in an offering even though a placement agent
experiences a disqualifying event while the offering is still
ongoing if: (a) the engagement with the placement agent was
terminated and the placement agent did not receive compensation for
the future sales; or (b) if the disqualifying event affected only
the covered control persons of the placement agent and such persons
were terminated or no longer performed roles that would cause them
to be considered Covered Persons for purposes of Rule 506(d).
The Guidance also provides that paid solicitors covered by Rule
506(d) are not limited to registered broker-dealers, but include
all persons who have been or will be paid directly or indirectly,
for solicitation of purchasers. However, a solicitor's
directors and officers who participate in an offering are included
in the list of Covered Persons if their participation includes
involvement in due diligence activities, preparation of offering
materials, providing structuring or other advice to the issuer in
connection with the offering and communicating with the issuer,
prospective investors or other offering participants about the
offering. The Guidance clarifies that these activities must be more
than transitory or incidental and do not include any persons whose
sole involvement in the offering is as a member of a paid
solicitor's deal or transaction committee that is responsible
for approving such solicitor's participation in the offering,
administrative functions, such as opening brokerage accounts,
wiring funds and bookkeeping activities.
Disclosure. The Guidance makes clear that issuers
may not waive the obligation to disclose past disqualifying events
that occurred prior to the September 23, 2013 effective date of
Rule 506(d). However, issuers are required to disclose only events
that would have triggered disqualification at the time of the
offering. With respect to solicitors, the Guidance clarifies that
issuers are required to provide disclosure of past disqualifying
events of all paid solicitors and their covered control persons who
are involved with the offering to all investors, and not only to
the investors that were solicited by such persons. However, issuers
are not required to provide disclosure with respect to paid
solicitors who are no longer involved in the offering.
Disqualification Triggers. The Guidance clarifies
that disqualification is not triggered by actions taken in
jurisdictions outside the U.S., such as convictions, court orders,
or injunctions in a foreign court or regulatory orders issued by
foreign regulatory authorities. The Guidance also provides that
disqualification is triggered only by cease and desist orders from
violations of scienter-based provisions of the federal securities
laws and rules. Further, if an order issued by a court or regulator
provides that Rule 506 disqualification should not arise as a
result of the order, it is not necessary to seek a waiver from the
SEC or to take any other action to confirm that a bad actor
disqualification will also not apply as a result of the order.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.