ATTORNEY ADVERTISING
Client Alert / December 2013
INVESTMENT MANAGEMENT
POINTS TO CONSIDER REGARDING THE SEC’S RECENT GUIDANCE WITH
RESPECT TO CERTAIN “BAD ACTOR” DISQUALIFICATIONS UNDER RULE 506
By Scott H. Moss, Esq., and Cole Beaubouef, Esq.
SEC Issues Interpretation on
the Scope of Rule 506(d) and
Rule 506(e)
As previously discussed in a July 2013
Lowenstein Sandler LLP Client Alert,
on July 10, 2013, the Securities and
Exchange Commission (“SEC”) adopted
certain amendments to Rules 501 and
506 of Regulation D that preclude
issuers from relying upon Rule 506 with
respect to private placements conducted
by or involving certain felons and other
“bad actors.”1 This rulemaking initiative
was in furtherance of a mandate
imposed by Section 926 of the DoddFrank Wall Street Reform and Consumer
Protection Act and covers certain bad
acts of an issuer, while relying on Rule
506 as well as certain bad acts of the
issuer’s affiliates, management and
certain service providers.
On Wednesday, December 4, 2013,
the SEC’s Division of Corporation
Finance published certain “Compliance
and Disclosure Interpretations” (the
“Interpretations”) that clarify the
application and scope of certain items
relating to the SEC’s rulemaking
initiative.2 A summary of certain key
Interpretations is set forth below.
Limitations on Scope of Bad
Actor Disqualifications
Rule 506(d) applies to ongoing offerings
under Rule 506 only, and only U.S.
actions trigger disqualification.
The Interpretations provide that bad
actor disqualifications do not apply to
issuers that are not engaged in a private
placement offering under Rule 506. That
is, if an offering does not rely on a Rule
506 exemption, or is not ongoing
(such as a privately placed pooled
investment vehicle that is closed to
new investments), Rule 506(d) does
not apply. The Interpretations also
provide that convictions, orders, bars
and suspensions in jurisdictions other
than the United States will not trigger
a bad actor disqualification event
under the SEC’s rules.
For purposes of Rule 506(d), an
“affiliated issuer” does not mean every
affiliate of the issuer.
The Interpretations provide that
the definition of “affiliated issuer”
is an affiliate of the issuer that
is “issuing securities in the same
offering, including offerings subject
to integration...” with the offering
for which Rule 506 is being used.
This Interpretation circumscribes
the application of the bad actor
restrictions and provides important
relief for issuers relying on Rule 506,
many of whom may have been
burdened with determining whether
various affiliates (including portfolio
companies of privately placed pooled
investment vehicles) were subject
to disqualifying events that would
prohibit the issuer from relying on
Rule 506.
The “reasonable care exception” to
Rule 506(d) can apply in a number of
circumstances.
The Interpretations provide additional
clarification with respect to the SEC’s
bad actor rules’ reasonable care
exception (which is an important
exception from the bad actor
disqualifications). Specifically, the
Interpretations provide that an issuer
may demonstrate “reasonable care”
in determining compliance with the
bad actor rules if the issuer (i) is
unable to determine the existence of
a disqualifying event; (ii) is unable to
determine that a particular person
was a covered person; or (iii) initially
reasonably determined that the
person was not a covered person
under the rules but subsequently
learned that such determination was
incorrect. The Interpretations provide,
further, that issuers must consider
what steps would be appropriate
upon discovery of disqualifying
events and covered persons and
may, moreover, be required to seek
waivers of disqualification and/or
terminate its relationship with
certain covered persons.
An issuer must determine if it is subject
to a bad actor disqualification any
time it is offering or selling securities
in reliance on Rule 506.
The Interpretations provide important
clarification with respect to the
manner in which issuers may satisfy
their obligation to determine whether
a covered person is subject to a
disqualifying event. Specifically, the
Interpretations provide that issuers
may reasonably rely on a covered
person’s covenant to provide notice of
actual or potential disqualifying events.
The Interpretations provide, further,
that issuers engaged in a continuous
offering are required to update their
inquiries on a periodic basis through
methods such as certifications,
questionnaires, database searches or
negative consents. The SEC did not
INVESTMENT MANAGEMENT
specify an exact method or timing of
updates. Rather, the SEC stated that
the nature and frequency of updates
depend on the circumstances, without
providing further guidance.
Various clarifying interpretations were
provided with respect to third-party
placement agents and solicitors.
With respect to placement agents and
solicitors (which the Interpretations
provide include all persons that
have been or will be paid, directly or
indirectly, remuneration for solicitation
of purchasers), the Interpretations
provide that issuers engaged in an
offering need not provide any bad
actor disclosures under Rule 506(e)
relating to compensated solicitors
that are not involved in the offering
at the time of sale. Also, to the extent
that a placement agent’s “covered
persons” participating in the offering
are subject to a disqualifying event,
the placement agent may continue to
participate in the issuer’s offering if
such covered persons are terminated
or no longer perform covered person
roles with the placement agent. Finally,
the Interpretations provide that bad
actor disclosure must be made to all
investors regarding all disqualifying
events committed by all compensated
solicitors involved in the issuer’s
offering at the time of sale, regardless
of which compensated solicitor
actually solicited an investor.
506 offerings. However, certain aspects
of these rules, and their effect on such
offerings, have been unclear. The SEC’s
Interpretations help to clarify certain
of these matters, and, therefore, it is
important for managers to familiarize
themselves with the Interpretations.
Lowenstein Sandler’s Investment
Management Group is available to assist
with these matters and will keep you
advised of any further developments.
David L. Goret
646.414.6837
[email protected]
Matthew A. Magidson
646.414.6952
[email protected]
Richard Bernstein
646.414.6842 (NY),
973.422.6714 (NJ)
[email protected]
Co-Authors:
contacts
Please contact any of the
attorneys listed, or any other
member of Lowenstein Sandler’s
Investment Management Group, for
further information on the matters
discussed in this client alert.
Scott H. Moss
646.414.6874
[email protected]
Cole Beaubouef
973.597.2322
[email protected]
Robert G. Minion
Chair
646.414.6930
[email protected]
Allen B. Levithan
973.597.2406
[email protected]
Marie T. DeFalco
646.414.6945 (NY),
973.597.6180 (NJ)
[email protected]
Peter D. Greene
646.414.6908
[email protected]
Next Steps
Elaine M. Hughes
973.422.6502
[email protected]
The SEC’s bad actor rulemaking
initiative has important implications
for fund managers conducting Rule
Scott H. Moss
646.414.6874
[email protected]
The previous Lowenstein Sandler LLP Client Alert discussing and analyzing the SEC’s rulemaking initiative is available here.
1
The Interpretations are available here (Questions 260.14 – 260.27).
2
www.lowenstein.com
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© 2013 Lowenstein Sandler LLP.
Lowenstein Sandler makes no representation or warranty, express or implied, as
to the completeness or accuracy of this Client Alert and assumes no responsibility
to update the Client Alert based upon events subsequent to the date of its
publication, such as new legislation, regulations, and judicial decisions. Readers
should consult legal counsel of their own choosing to discuss how these matters
may relate to their individual circumstances.