Regulation D Rule 506 Proposal: SEC Proposes Rules Disqualifying Unregistered Securities Offerings Involving “Bad Actors” from Reliance on the Rule 506 Safe Harbor

Sullivan & Cromwell LLP - June 29, 2011
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The Securities and Exchange Commission has proposed rules implementing Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 926 requires the SEC to issue rules that disqualify securities offerings involving felons and other “bad actors” from reliance upon Rule 506 of Regulation D under the Securities Act of 1933, which provides a safe harbor from Securities Act registration requirements. The new rules are required to be “substantially similar” to the disqualification provisions of Rule 262 under the Securities Act, which apply to offerings under Regulation A and Rule 505 of Regulation D, and to expand the list of disqualifying events to include certain state regulatory and other actions specified in Section 926.

The proposed new rules would require an issuer to make a factual inquiry to determine whether any covered person is subject to a disqualifying event, which may be ongoing or may be as many as five or ten years old, depending on the nature of the event. Covered persons would include the issuer, any person paid to solicit purchasers in the offering and a broad range of related persons, such as officers, directors, general partners and 10% equity owners of the issuer or any paid solicitor.

The SEC would have the authority to grant waivers from disqualification upon a showing of good cause. However, the SEC does not propose to “grandfather” disqualifying events that have occurred before the new rules take effect, although it has asked for comment on several possible grandfathering approaches. Unless the SEC modifies the proposed rules to grandfather prior events, issuers and securities firms may need to seek waivers for events occurring before the effective date of the rules.