SEC Guidance on “Bad Actor” Disqualifications from Rule 506 Offerings

On January 3, 2014, the SEC issued new Compliance and Disclosure Interpretations (C&DIs) clarifying the application of the “bad actor” disqualifications from Rule 506 offerings.  Generally, under the new Rule 506(d), an issuer may not rely on the Rule 506 registration exemption if the issuer or any other person covered by Rule 506(d) is subject to a bad actor triggering event at the time of each sale of securities.  Most of the new C&DIs focused on one category of such covered persons – a beneficial owner of 20% or more of the issuer’s outstanding voting equity securities.  Please see below a summary of such C&DIs.

  • A shareholder that becomes a 20% beneficial owner upon completion of a sale of securities is NOT a 20% beneficial owner at the time of such sale.  However, it would be a covered person with respect to any sales of securities in the offering that were made while it was a 20% beneficial owner.  
  • The term “beneficial owner” under Rule 506(d) means any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares, or is deemed to have or share:  (1) voting power, which includes the power to vote, or to direct the voting of, such security; and/or (2) investment power, which includes the power to dispose, or to direct the disposition of, such security. 
  • For purposes of determining 20% beneficial owners under Rule 506(d), it is necessary to “look through” entities to their controlling persons because beneficial ownership includes both direct and indirect interests (see Exchange Act Rule 13d-3). 
  • If some of the shareholders have entered into a voting agreement under which each shareholder agrees to vote its shares of voting equity securities in favor of director candidates designated by one or more of the other parties, which effectively means that such shareholders have formed a group, then the group beneficially owns the shares beneficially owned by its members (see Exchange Act Rules 13d-3 and 13d-5(b)).  In addition, the parties to the voting agreement that have or share the power to vote or direct the vote of shares beneficially owned by other parties to the agreement (through, for example, the receipt of an irrevocable proxy or the right to designate director nominees for whom the other parties have agreed to vote) will beneficially own such shares.  Parties that do not have or share the power to vote or direct the vote of other parties’ shares would not beneficially own such shares solely as a result of entering into the voting agreement (see another new C&DI issued by the SEC on January 3, 2014).  If the group is a 20% beneficial owner, then disqualification or disclosure obligations would arise from court orders, injunctions, regulatory orders or other triggering events against the group itself.  If a party to the voting agreement becomes a 20% beneficial owner because shares of other parties are added to its beneficial ownership, disqualification or disclosure obligations would arise from triggering events against that party. 

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