Wavering on Waivers—Bad Boy/Bad Actor Waivers Under Federal and State Law (Part 2)

Disqualifications Brought to Rule 506

Historically, even with a disqualification under Rule 505, an issuer could use Rule 506. That has no longer been the case since September 23, 2013, when Rule 506(d) became effective due to the mandate set forth in the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010. Rule 506(d) (the “Bad Actor Provisions”) is a disqualification from the ability to use Rule 506 by bad actors. While the Bad Actor Provisions are similar to the provisions under Regulation A (before the 2015 amendments), they were not the same. For example, 

  • In Rule 506(d) one of the categories of covered persons includes beneficial owners of 20 percent or more of an issuer’s voting equity securities, whereas in Rule 262 of Regulation A and Rule 505 of Regulation D, the category includes beneficial owners of 10 percent or more of any class of the issuer’s equity securities.
  • Another category of covered persons in Rule 506(d), but not in Rule 262 and Rule 505, includes any investment manager of an issuer that is a pooled investment fund and any director, executive officer, or other officer participating in the offering, of any such investment manager or general partner or managing member of such investment manager.  
    • Although the disqualifying events in Rule 506(d) are also similar to disqualifying events in Rule 262, they are broader in certain respects. In addition to certain administrative orders, industry bars, injunctions involving securities law violations and specified criminal convictions covered under Regulation A and Rule 505, the disqualifying events in Rule 506(d) also include:
      • Commission cease and desist orders involving scienter-based antifraud provisions of the federal securities laws and violations of Section 5 of the Securities Act; and 
      • Final orders of certain state and federal regulatory authorities that impose a bar from association with a regulated entity, engaging in the business of securities, insurance or banking, or engaging in savings association or credit union activities, or a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative or deceptive conduct and is issued within ten years of the proposed sale of securities. 

As amended, the Rule 262 Bad Actor disqualification is substantially the same as the Rule 506(d) Bad Actor disqualification. In neither rule is there a requirement that the actions from which the disqualification derives be scienter-based, although some actions (such as a criminal conviction, (Rule 262(a)(1) and Rule 506(d)(1)(i)) or a “scienter-based anti-fraud provision of the federal securities laws” (Rule 262(a)(5)(i) and Rule 506(d)(1)(v)(A)) do require some level of intent. Notably, the Bad Actor rules do not include final orders of Canadian provincial regulators in the list of disqualifying events. 

The effective date for new Rule 262 is June 19, 2015, although there are complex transition rules in Rule 262(b).  For the Bad Actor Provisions of Rule 506(d) to be applicable, the disqualifying events must have occurred on or after September 23, 2013. Where the events occurred before the effective dates of the rules (September 23, 2013 for Rule 506; June 19, 2015 for Regulation A), the issuers must still comply with the disclosure requirements of Rule 262(d) or Rule 506(e) (as applicable). (Note that the “disqualifying event” is not the action that led to the criminal conviction or final order of the applicable federal or state regulator, but the conviction or order.)  Much of this is explained in the SEC’s “A Small Entity Compliance Guide” (September 19, 2013). 

Reprinted from The Colorado Bar Association, Business Law Section, May 2015 

Herrick Lidstone