The SEC recently amended Regulation D to make Rule 506 unavailable if the issuer of a security, any persons involved with promotion or sale of the security, or any of numerous categories of persons who have some relationship with any of such persons, have been subject to any "disqualifying event." Amended Rule 506 – which is commonly relied on to exempt private securities offerings from registration -- defines such disqualifying events to include a wide variety of felony and misdemeanor convictions, other court orders and injunctions, and regulatory orders.
If the issuer establishes that it did not know and, in the exercise of reasonable care, could not have known of a disqualification, it can still rely on the Rule 506 exemption. The instructions to the new requirement, however, make clear that, in order to rely on this exception, an issuer must make a reasonable factual inquiry into whether any disqualifying event exists.
The SEC indicated that, although in some cases an issuer might reasonably rely solely on a person’s signed questionnaire or similar documentation to establish the absence of any disqualifying event as to that person, the reasonableness of an issuer’s factual inquiry will vary based on the facts and circumstances of the issuer and other offering participants.
The "bad actor" prohibition therefore injects a somewhat vague, "principles-based" element into the requirements of Rule 506. This move away from the rule’s previously more "rules-based" approach, together with other potential complexities of identifying and making reasonable factual inquiries as to all necessary persons, will, in many cases, materially increase the costs, burdens and risks of reliance on Rule 506.
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