Have you been a “Bad Actor”? Maybe You Should Just Beg for Forgiveness.

Rule 506 under the Securities Act of 1933 is the most widely used exemption from the registration requirements of the Securities Act. The exemption is used by a wide range of issuers from small, start-up companies to the largest investment and hedge funds. Rule 506 generally permits issuers to sell an unlimited amount of securities to an unlimited number of accredited investors. However, pursuant to Section 926 of the Dodd-Frank Act, the SEC adopted Rule 506(d) disqualifying securities offerings involving certain felons and other “bad actors” from reliance on the Rule 506 exemption. Rule 506(d) became effective on September 23, 2013.  

Rule 506(d)(2)(ii) provides that the disqualification shall not apply “upon a showing of good cause . . . if the Commission determines that it is not necessary under the circumstances that an exemption be denied.” Similar disqualification provisions are applicable to offerings exempt from registration pursuant to Regulation A and Rule 505(b). However, neither Regulation A nor Rule 505 is relied upon nearly as often as Rule 506 because of the inherent limitations of those rules. Therefore, the impact of the bad actor disqualifications under Regulation A and Rule 505 has been somewhat limited. However, given the wide use of the Rule 506 exemption, we can expect many more issuers and others involved in securities offerings to request waivers.    

Since Rule 506(d) became effective, the SEC has granted exemptions to five issuers, four of which are financial institutions. In each case, the “bad act” which led to possible disqualification (I say possible because none of the entities requesting exemption actually admitted to disqualification) was an order or judgment entered with the consent or acquiescence of the financial institution.

Generally, each of the requests for exemption cited the following facts: the bad conduct did not involve the offer or sale of securities pursuant to Regulation A or Regulation D; steps have been taken to address the underlying conduct; and disqualification would have an adverse impact on third parties. In addition, each company requesting the exemption also committed to furnishing to each purchaser in certain exempt offerings disclosure of the “bad acts.”

In each case, the order or judgment giving rise to the disqualification, the letter from the financial institution requesting an exemption from Rule 506(d)’s disqualification provision and the letter from the SEC staff confirming that the exemption had been granted, all bear the same date. Most likely the granting of the exemption was part of the overall settlement of the matters that were the subject of the various orders. The four letters can be found here, here, here and here.

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