On May 25, 2011, the Securities and Exchange Commission (the “SEC”) proposed rules to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) which would amend Rules 501 and 506 of Regulation D (“Regulation D”) under the Securities Act of 1933 (the “Securities Act”). The proposal would disqualify securities offerings in reliance upon Rule 506 by issuers who are disqualified themselves, or are associated with certain “bad actors” and would provide an exemption for issuers that exercise “reasonable care” and did not or could not have known that a disqualification existed.
About Regulation D
Regulation D provides a safe harbor under which issuers may offer and sell securities without registration under the Securities Act. Specifically, Rule 506 permits “sales of an unlimited dollar amount of securities to be made, without registration, to an unlimited number of accredited investors, as long as there is no general solicitation, appropriate resale limitations are imposed, and applicable information requirements are satisfied.”
Under the SEC’s proposed rules, issuers and certain persons who commit or have committed specified “bad actors” would be barred from participating in an exempt securities offering under Rule 506, subject to an exemption for issuers exercising “reasonable care.”
What is a Bad Actor?
Disqualification provisions of the SEC’s proposals would apply to the following persons:
(i) any issuer, or any predecessor of the issuer or affiliated issuer;
(ii) any director, officer, general partner or managing member of the issuer;
(iii) any beneficial owner of 10% or more of any class of the issuer’s equity securities;
(iv) any promoter connected with the issuer in any capacity at the time of the sale;
(v) any person that has been, or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering; and
(vi) any general partner, director, officer, or managing member of any such compensated solicitor.
Rule 405 of the Securities Act defines “promoter” to mean (i) any person who, acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer, or (ii) any person who, in connection with the founding and organizing of the business or enterprise of an issuer, directly or indirectly receives in consideration of services or property, or both services and property, 10 percent or more of any class of securities of the issuer or 10 percent or more of the proceeds from the sale of any class of the securities. Rule 405 defines an “officer” as a “president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any person routinely performing corresponding functions with respect to any organization.”
Summary of Disqualifying Acts
Rule 506(c)(1)(i)
Proposed Rule 506(c)(1)(i) triggers a disqualification if a covered person has been convicted of any state or federal felony or misdemeanor for persons (other than an issuer, its predecessor or an affiliated issuer) convicted within 10 years of the proposed sale; and Issuers, their predecessors and affiliated issuers convicted within 5 years of the proposed sale:
♦ in connection with the purchase or sale of any security;
♦ involving any false filing with the SEC; or
♦ arising out of business conduct of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.
Proposed Rule 506(c)(1)(ii)
Proposed Rule 506(c)(1)(ii) triggers a disqualification if a covered person is subject to any court order, judgment, or decree. With respect to a court order, judgment, or decree, the Order must be entered within 5 years of the proposed sale of securities:
♦ that restrains the person from engaging in any conduct in connection with the purchase or sale of any security;
♦ involving any false filing with the SEC; or
♦ arising out of business conduct of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.
Rule 506(c)(1)(iii)
Proposed Rule 506(c)(1)(iii) triggers a disqualification if a covered person is subject to a final order of a state securities, banking and insurance regulator; federal banking agency; or the National Credit Union Administration. Proposed Rule 501(g) defines “final order” to mean a written directive or declaratory statement issued pursuant to applicable statutory authority and procedures which constitutes a final disposition or action by a federal or state agency.
At the time of the proposed sale, the final order must:
♦ bar the covered person from (a) associating with an entity regulated by such commission, authority, agency, or officer; (b) engaging in the business of securities, insurance, or banking; or (c) engaging in savings association or credit union activities; or
♦ constitute an order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct.
Rule 506(c)(1)(iv)
Proposed Rule 506(c)(1)(iv) triggers a disqualification if a covered person is subject to any SEC disciplinary order relating to brokers, dealers, municipal securities dealers, investment advisers and investment companies which:
♦ suspends or revokes a person’s registration as a broker, dealer, municipal securities dealer or investment adviser;
places limitations on the activities of such person; or
♦ bars the person from participating in the offering of any penny stock.
The Order disqualifies a covered person for period of time equivalent to the duration of the suspension or limitation of activities by the SEC.
Rule 506(c)(1)(vi)
Proposed Rule 506(c)(1)(vi) triggers a disqualification if a covered person filed or was named as an underwriter in a registration statement or Regulation A offering statement which was subject to a refusal order, stop order, or order suspending the Regulation A exemption. The Order must be entered within 5 years of the proposed sale, and the covered person is also disqualified if, at the time of the proposed sale, the covered person is subject to an investigation or procedure to determine whether a stop or suspension order must be issued.
Rule 506(c)(1)(vii)
Proposed Rule 506(c)(1)(vii) triggers a disqualification if a covered person is subject to a U.S. Postal Service false representation order. The order must be entered within 5 years of the proposed sale or at the time of the proposed sale, the covered person is subject to a temporary restraining order or preliminary injunction for conduct pertaining to obtaining money or property through the mail by means of false representation.
Transitioning to Rule 506(c)
Under the SEC’s proposals, offerings that occur after the rule’s effective date will be subject to disqualification from the Rule 506 exemption for all disqualifying acts which occurred during the applicable “look-back” period discussed above. The SEC release notes that if a disqualifying act takes place while an offering is being conducted, sales made before the act would remain unaffected; however, offers and sales taking place after the act would not qualify for the private placement safe harbor exemption under the proposals.
Comment Period
The SEC is accepting comments on the proposed amendments until July 14, 2011. Note that the final rules may contain notable differences from the proposed rules.
For more information about Rule 506 please visit our blog post at:
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton Florida, (561) 416-8956, by email at info@securitieslawyer101.com or visit www.gopublic101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. For more information about going public and the rules and regulations affecting the use of Rule 144, Form 8K, crowdfunding, FINRA Rule 6490, Rule 506 private placement offerings and memorandums, Regulation A, Rule 504 offerings, SEC reporting requirements, SEC registration statements on Form S-1 , IPO’s, OTC Pink Sheet listings, Form 10 OTCBB and OTC Markets disclosure requirements, DTC Chills, Global Locks, reverse mergers, public shells, direct public offerings and direct public offerings please contact Hamilton and Associates at (561) 416-8956 or info@securitieslawyer101.com. Please note that the prior results discussed herein do not guarantee similar outcomes.
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Brenda Hamilton, Securities Attorney
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Boca Raton, Florida 33432
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