New SEC Guidance on “Bad Actor” Disqualification Events for Accredited Investor Offerings Under Rule 506
On December 4, 2013, the United States Securities and Exchange Commission (the “SEC”) issued new Compliance and Disclosure Interpretations (“C&DIs”) clarifying certain aspects of the application of the “bad actor” disqualification events for offerings to “accredited investors” in reliance on Rule 506. Generally, an issuer may not rely on Rule 506 if the issuer or any other person covered by Rule 506(d) has experienced a disqualifying event that occurred on or after September 23, 2013 (the effective date of new Rule 506(d)). A disqualifying event that occurred before September 23, 2013 triggers certain disclosure obligations under Rule 506(e) a reasonable time prior to any sales in a Rule 506 offering. This client alert supplements our previously issued client alert dated October 8, 2013, which discusses in much greater detail the new Rule 506(d) and Rule 506(e) provisions. A link to such client alert has been provided below. Below is a summary of certain of the more relevant C&DIs issued by the SEC, as well as a link to the full C&DIs.
When is an issuer required to determine whether bad actor disqualification under Rule 506(d) applies?
Rule 506(d) disqualifies an offering of securities from reliance on a Rule 506 exemption from Securities Act registration. Issuers must therefore determine if they are subject to bad actor disqualification any time they are offering or selling securities in reliance on Rule 506. An issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to, for example, contractual covenants, bylaw requirements, or an undertaking in a questionnaire or certification. However, if an offering is continuous, delayed or long-lived, the issuer must update its factual inquiry periodically through bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.
Does the reasonable care exception only cover circumstances where the issuer has identified all covered persons but, despite the exercise of reasonable care, was unable to discover the existence of a disqualifying event?
The reasonable care exception applies whenever the issuer can establish that it did not know and, despite the exercise of reasonable care, could not have known that a disqualification existed under Rule 506(d)(1). This may occur when, despite the exercise of reasonable care, the issuer was unable to determine the existence of a disqualifying event, was unable to determine that a particular person was a covered person, or initially reasonably determined that the person was not a covered person but subsequently learned that determination was incorrect.
Is disqualification under Rule 506(d) triggered by actions taken in jurisdictions other than the United States, such as convictions, court orders, or injunctions in a foreign court, or regulatory orders issued by foreign regulatory authorities?
No.
Are compensated solicitors limited to registered brokers and their associated persons?
No, all persons who have been or will be paid, directly or indirectly, remuneration for solicitation of purchasers are covered by Rule 506(d), regardless of whether they are, or are required to be, registered under Exchange Act or are associated persons of registered broker-dealers. The disclosure required in Item 12 of Form D expressly contemplates that compensated solicitors may not appear in FINRA’s Central Registration Depository (CRD) of brokers and brokerage firms.
In an offering in which the issuer uses multiple placement agents or other compensated solicitors, is the issuer required to provide investors with disclosure under Rule 506(e) only with respect to the particular compensated solicitor or placement agent that solicited those investors and its covered control persons?
No, issuers are required to provide all investors with the Rule 506(e) disclosure for all compensated solicitors who are involved with the offering at the time of sale and their covered control persons.
Are officers of a compensated solicitor deemed to be “participating” in a Rule 506 offering only if they are involved with the solicitation of investors for that offering?
No, participation in an offering is not limited to solicitation of investors. Examples of participation in an offering include participation or involvement in due diligence activities or the preparation of offering materials (including analyst reports used to solicit investors), 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. To constitute participation for purposes of the rule, such activities must be more than transitory or incidental. Administrative functions, such as opening brokerage accounts, wiring funds, and bookkeeping activities, would generally not be deemed to be participating in the offering.
In our previously issued client alert, we set forth several recommendations for issuers and broker-dealers to ensure compliance with the new rule amendments and to establish a basis for the application of the reasonable care exception under Rule 506(d), and we suggest that issuers and broker-dealers carefully read and follow such recommendations. If you have any questions regarding this alert or our suggested steps to ensure compliance with these new rule amendments, please feel free to contact either Tom Rose at (757) 687-7715 or Shona Smith at (503) 290-2335.
The link to the full C&DIs, which begin at Question 260.14, is below:
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm
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