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June 2, 2011


On May 25, 2011, the SEC proposed amendments to Rule 506 of Regulation D promulgated under Section 4(2) of the Securities Act of 1933, as amended (“Securities Act”), to prohibit certain felons and other “bad actors” from participating in securities offerings in reliance upon the rule’s safe harbor exemption from registration under the Securities Act.  The proposed amendments would implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 


The proposed disqualification from participation in exempt securities offerings pursuant to Rule 506 would apply to “covered persons,” including an issuer relying upon the exemption, its officers, directors, 10% shareholders, placement agents and finders, that have a “disqualifying event.”

Rule 506 permits sales of an unlimited dollar amount of securities to be made without registration under the Securities Act to an unlimited number of accredited investors and up to 35 non-accredited investors, provided there is no general solicitation, appropriate resale limitations are imposed on the securities sold in the offering, certain information requirements are satisfied, a Form D is filed with the SEC, and certain other conditions are met. 


The SEC stated in the proposing release that Rule 506 is the most widely used Regulation D safe harbor exemption, accounting for an estimated 90-95% of all Regulation D offerings.  Rule 506 does not currently have any bad actor disqualification requirements.  Also, because securities sold under Rule 506 are “covered securities” under Section 18(b)(4)(D) of the Securities Act, state-level bad actor disqualification provisions do not apply to offerings in reliance upon the rule.


Proposed Disqualification Requirements


Covered Person


The disqualification provisions of the proposed amendments would apply to the following persons (referred to in the proposed rule amendments as “covered persons”):

  • an issuer and any predecessor of the issuer or affiliated issuer

  • any director, officer, general partner or managing member of the issuer

  • any beneficial owner of 10% or more of any class of the issuer’s equity securities

  • any promoter connected with the issuer in any capacity at the time of the sale

  • any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering, such as placement agents, or

  • any director, officer, general partner, or managing member of any such compensated solicitor


The SEC is not proposing to cover investment advisers of issuers (such as funds), or the directors, general partners, or managing members of such investment advisers.


Disqualifying Event


The proposed amendments to Rule 506 define a “disqualifying event” to include any of the following events with regard to a covered person:

  • a felony or misdemeanor conviction in connection with the purchase or sale of a security, involving the making of any false filing with the SEC, or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities  that occurred within ten years before the sale of the security (or five years, in the case of issuers, predecessors and affiliated issuers)

  • an order, judgment, or decree of a court of competent jurisdiction entered within five years before the sale of the security that, at the time of such sale, restrains or enjoins the covered person from engaging or continuing to engage in any conduct or practice in connection with the purchase or sale of any security, involving the making of any false filing with the SEC, or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities

  • a  final order of a state securities, bank, savings association, credit union, or insurance commission, federal banking agency, or the National Credit Union Administration that (i) at the time of the sale of the security, bars the person from association with an entity regulated by such commission, from engaging in the business of securities, insurance or banking, or from engaging in savings association or credit union activities; or (ii) constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before such sale

  • a suspension or expulsion from membership in, or a suspension or a bar from association with a member of, a registered national securities exchange or a registered national or affiliated securities association for any act or omission to act that constitutes conduct inconsistent with just and equitable principles of trade

  • the filing of a registration statement or Regulation A offering statement with the SEC (or being named as an underwriter in any such filing) within five years before the sale of the security that was the subject of an SEC refusal order, stop order, or order of suspension or, at the time of the sale, was the subject of an investigation or proceeding to determine whether a stop order or suspension order should be issued

  • a U.S. Postal Service false representation order entered within five years before the sale of the security, or, at the time of such sale, a temporary restraining order or preliminary injunction with respect to conduct alleged by the U.S. Postal Service to constitute a scheme or device for obtaining money or property through the mail by means of false representations


“Reasonable Care” Exception


The disqualification will not apply if the issuer did not know, and in the exercise of reasonable care could not have known, that a disqualification existed.  The notes to the rule state that an issuer will not be able to establish it exercised reasonable care unless it has made a factual enquiry into whether any disqualification exists. 


The SEC states in its proposing release that issuers are responsible for screening bad actors out of their Rule 506 offerings.  Accordingly, an issuer proposing to rely on Rule 506 will need to make a written enquiry of its officers, directors, 10% holders and others whether they are the subject of any disqualifying event and incorporate appropriate representations into its agreements with placement agents.


Affiliated Issuers


A disqualifying event relating to any affiliated issuer that occurred before the affiliation arose will not be a disqualifying event provided the affiliated entity is not either in control of the issuer or under common control with the issuer by a person that was in control of the affiliated entity at the time of the disqualifying event.


SEC Waiver Authority


The proposed rule includes a provision that would permit the SEC to grant a waiver where the issuer can show good cause and without prejudice to any other action by the SEC, if the SEC determines that it is not necessary under the circumstances that an exemption be denied.


Form D Certification


The SEC has proposed an amendment to the Form D to add a certification under the heading “Terms of Submission” of the form that would require an issuer to certify that it is not disqualified from relying upon the rule by reason of a disqualifying event by a covered person.


Rule 504, Rule 505, Regulation A and Regulation E Offerings


Among other things, the SEC is soliciting comment on whether to apply the new bad actor disqualification provisions uniformly to all offerings under Rule 504, Rule 505, Regulation A and Regulation E.


Public comments on the proposed rule amendments are requested by July 14, 2011.


Under the new rules, the SEC is required to pay an award to eligible whistleblowers that voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful enforcement action which results in $1 million or more in monetary sanctions. 


Section 21F of the Exchange Act prohibits an employer from retaliating against an employee for, among other things, providing information to the SEC or initiating, testifying in, or assisting in any investigation or SEC enforcement action based on information tipped to the SEC. The protections apply whether or not the whistleblower is entitled to an award under the statute and related regulations.


A whistleblower may be able to receive between 10% and 30% of any monetary sanctions collected because of the information tipped to the SEC. 


The rules have been adopted substantially as proposed by the SEC.   


The new rules do not include a requirement that a whistleblower report internally first before submitting information to the SEC. However, the rule does include certain incentives for a whistleblower that uses a company’s internal compliance and reporting system.


Also, the final rules include a 120 day “look back” period.  This period extends the time for a whistleblower to report information to the SEC after first reporting internally and still be treated as if he had reported to the SEC at the earlier reporting date.



For more information, please contact:


Neil R.E. Carr
Direct Dial: +1 202 587 2983

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