Disqualification under Regulation D

On July 31st, in what many are hailing as a landmark change, the Securities and Exchange Commission (SEC) adopted amendments to the rules governing the Regulation D waivers. The major thrust of these changes were based on the Jumpstart Our Business Startups (JOBS Act) signed into law by President Obama on April 5th, 2012. The SEC simultaneously adopted amendments designed to implement section 926 of the Dodd Frank Wall Street Reform Act, which disqualifies certain individuals from participating in exempt securities offerings. These “bad actors” being banned from participation is good news for investors and potentially sends a serious message about ethical behavior to the entire community.

Section 926 of the Dodd-Frank Act requires the SEC to adopt rules that would make the Rule 506 exemption unavailable for any securities offering in which certain “felons” or other “bad actors” are involved. The new provisions generally track those in Section 926 of the Dodd-Frank Act and Rule 262 of Regulation A under the Securities Act. Any “covered person” under the provisions of Rule 506 (d)(1) would be automatically bared from participating in exempt securities offering, regardless of the making of a public offering or not. The definition of a “covered person” has been extended significantly and now includes –

  • The issuer and any predecessor of the issuer;
  • Any affiliated issuer;
  • Any director, executive officer, other officer participating in the offering, general partner, or managing member of the issuer;
  • Any beneficial owner of 20 percent or more of any class of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • Any promoter (as defined in Rule 405) connected with the issuer in any capacity at the time of the sale;
  • Any investment manager of an issuer that is a pooled investment fund;
  • Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with such sale of securities (a “compensated solicitor”);
  • Any general partner or managing member of any such investment manager or compensated solicitor; or
  • Any director, executive officer or other officer participating in the offering of any such investment  manager or compensated solicitor or general partner or managing member of such investment manager or compensated solicitor.

The exception to the disqualifying provision through affiliation is only if the disqualifying event occurred prior to the parties being associated and the issuer had no control of the party at the time.

The SEC further goes on to clarify the disqualification under Regulation D events to include the following eight categories:

  • Criminal convictions;
  • Court injunctions and restraining orders;
  • Final orders (as defined in Rule 501(g)) of certain state regulators (such as securities, banking, and insurance) and federal regulators, including the U.S. Commodity Futures Trading Commission (the “CFTC”);Attorney Advertisement
  • Commission disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers, and investment companies and their associated persons;
  • Certain SEC cease and desist orders;
  • Suspension or expulsion from membership of, a securities self-regulatory organization (“SRO”);
  • Commission stop orders and orders suspending a Regulation A exemption; and
  • U.S. Postal Service false representation orders.

By broadening and tightening the scope of “bad actors” the SEC has taken active steps to prevent people and organizations with a bad reputation or intention from taking advantage of the Regulation D exemption, accomplishing one of the critical intentions of the Dodd Frank Act.

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