The Bad Actor Rule for Regulation D, formally known as Rule 506(d), is a crucial Securities and Exchange Commission (SEC) regulation designed to protect investors by disqualifying certain individuals and entities from participating in private securities offerings. Essentially, it prevents anyone who has engaged in specific "disqualifying events" from being involved in any offer made under Regulation D.
Understanding Rule 506(d)
Rule 506(d) is a fundamental component of Regulation D, particularly for offerings under Rule 506(b) and Rule 506(c). It mandates that if a "Bad Actor" is part of the issuing team for a Regulation D offering, the SEC will automatically disqualify the entire offering. This means that even if the offering otherwise complies with all other aspects of Regulation D, the involvement of a Bad Actor renders it non-compliant and invalid in the eyes of the SEC.
Who is Considered a "Bad Actor"?
A "Bad Actor" is an individual or entity that has been involved in certain disqualifying events. While the specific list of such events is extensive and detailed within the rule, they generally pertain to serious financial or securities-related misconduct, such as:
- Felony or misdemeanor convictions involving the purchase or sale of any security, making of a 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.
- Court orders, injunctions, or regulatory orders prohibiting certain activities in connection with securities.
- Suspensions or expulsions from membership in a self-regulatory organization (like FINRA) or from association with a member.
- SEC orders barring or suspending association with certain regulated entities.
- Stop orders or orders suspending the effectiveness of a Regulation A filing.
It's important to note that these disqualifying events affect not only the individual directly involved but also have broad implications for any offering they are associated with.
Impact on Regulation D Offerings
The implications of the Bad Actor Rule are severe and directly impact the viability of a private offering:
- Broad Scope: The rule applies to a wide range of individuals and entities associated with the offering, including the issuer itself, its directors, officers, managing members, general partners, beneficial owners of 20% or more of the issuer's outstanding voting equity securities, promoters, and certain compensated solicitors.
- Offering Disqualification: The most significant consequence is that if any individual or entity covered by the rule has engaged in a disqualifying event and is part of the issuing team, the entire offering becomes disqualified. This means the offering cannot rely on the exemptions provided by Regulation D, making it an unregistered and potentially illegal offering.
- Due Diligence Requirement: Issuers conducting Regulation D offerings must perform thorough due diligence on all individuals and entities associated with the offering to ensure no Bad Actors are involved. This often involves background checks and obtaining representations from these parties.
The following table summarizes key aspects of the Bad Actor Rule:
| Aspect | Description |
|---|---|
| Rule Name | Rule 506(d) of Regulation D |
| Core Purpose | To prevent individuals or entities with a history of serious financial or securities-related misconduct (Bad Actors) from participating in private securities offerings under Regulation D, thereby protecting investors. |
| Applies To | The issuer and its predecessors and affiliates; directors, officers, general partners, and managing members of the issuer; beneficial owners of 20% or more of the issuer's outstanding voting equity securities; promoters connected with the issuer; and certain compensated solicitors, along with their partners, officers, directors, and managing members. |
| Triggering Events | Engagement in specific "disqualifying events," such as certain felony or misdemeanor convictions, court orders, SEC orders, or suspensions/expulsions from self-regulatory organizations, that occurred within a defined look-back period. |
| Consequence of Violation | If a Bad Actor is part of the issuing team, the SEC will disqualify the entire Regulation D offering, rendering it unable to rely on the Rule 506 exemption. The disqualifying events do not just affect the individual in question; they impact the validity of the offering itself. |
The Bad Actor Rule emphasizes the SEC's commitment to investor protection by ensuring that those with a history of misconduct are not involved in private capital-raising efforts that rely on exemptions from full registration.
