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From Securities Regulation Daily, September 20, 2013
By John Filar Atwood
The SEC has issued a
The rule amendments provide that an offering is disqualified from relying on Rule 506(b) and 506(c) of Regulation D if the issuer, or any other person covered by Rule 506(d), has a relevant criminal conviction, a regulatory or a court order, or other disqualifying event that occurred on or after September 23, 2013. For disqualifying events that occurred before September 23, issuers may still rely on Rule 506, but will have to comply with the disclosure provisions of Rule 506(e).
Covered persons. The compliance guide explains in detail the categories of persons that are covered by Rule 506(d). Understanding who is covered is important, according to the staff, because issuers are required to conduct an inquiry to determine whether a covered person has had a disqualifying event. If they have, the offering will either be disqualified from reliance on Rule 506 or the event will have to be disclosed to investors.
The guidance states that, for purposes of Rule 506, covered persons include the issuer, including predecessor and affiliated issuers, directors, general partners and managing members of the issuer. Covered persons also include executive officers of the issuer and other officers of the issuer that participate in the offering, as well as 20 percent beneficial owners of the issuer. For pooled investment fund issuers, the fund’s investment manager and its principals are covered persons. The definition also applies to persons compensated for soliciting investors, including their directors, general partners and managing members.
Disqualifying events. The guide provides background on different categories of disqualifying events under Rule 506. In general, disqualifying events include certain criminal convictions, certain court injunctions and restraining orders, and final orders of certain state and federal regulators. They also include certain SEC disciplinary orders and cease-and-desist orders, as well as SEC stop orders and orders suspending the Regulation A exemption.
The compliance guide indicates that suspension or expulsion from membership in a self-regulatory organization, such as FINRA, or from association with an SRO member constitutes a disqualifying event, as do U.S. Postal Service false representation orders. The staff advises that many disqualifying events include a look-back period, which is measured from the date of the disqualifying event, and not the date of the underlying conduct that led to the disqualifying event.
Exceptions and waivers. The staff notes in the guidance that Rule 506 provides an exception from disqualification when the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering. An issuer will not be able to establish that it has exercised reasonable care unless it has made a factual inquiry into whether any disqualification exists.
Issuers may seek waivers of disqualification from the SEC in certain circumstances. The staff notes that the grant of waivers will depend upon the specific facts and circumstances of each request. A waiver also is available if, before the relevant sale is made in reliance on Rule 506, a court or regulatory authority that entered a related order, judgment or decree advises in writing that disqualification under Rule 506 should not arise as a consequence of the order, judgment or decree.
Pre-existing events. The guidance notes that disqualification will not arise as a result of disqualifying events that occurred before September 23, 2013. However, those events must be disclosed in writing to investors a reasonable time before the Rule 506 sale. Rule 506 is unavailable to an issuer that fails to provide the required disclosure, unless the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a disqualifying event was required to be disclosed.
The staff advises that the rule looks to the timing of the triggering event, and not the timing of the underlying conduct, when determining whether disclosure is required. The staff notes that a triggering event that occurs after the effective date of the rule amendments will result in disqualification, even if the underlying conduct occurred before effective date. The staff states that issuers are expected to give reasonable prominence to the disclosure to ensure that information about pre-existing bad actor events is appropriately presented in the total mix of information available to investors.
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