bad actor

SEC defines “compensated solicitor” and “participation” under bad actor Rule 506(d)

As we reported previously, on September 23, 2013, new Rules 506(d) and (e) of Regulation D under the Securities Act and changes to Form D (“Bad Actor Rules”) went into effect, making all Rule 506 offerings subject to certain disqualification, disclosure and certification requirements.

In this blog, we want to bring to your attention the SEC’s compliance and disclosure interpretations (“C&DIs”) issued December 4, 2013, which, among other provisions, define what constitutes a “compensated solicitor” and “participation” in an offering, in case the SEC’s expanded guidance warrants an assessment of your particular services, especially if you are a professional advisor.

The CD&Is define “compensated solicitors” as “all persons who have been or will be paid, directly or indirectly, remuneration for solicitation of purchasers, regardless of whether they are, or are required to be, registered under Exchange Act Section 15(a)(1) or are associated persons of registered broker-dealers.”

According to the CD&Is, “participation in an offering is not limited to the solicitation of investors, and includes involvement in due diligence activities or the preparation of offering materials (including analyst reports used to solicit investors), providing structuring or other advice to the issuer in connection with the offering, and communicating with the issuer, prospective investors or other participants about the offering. To constitute ‘participation,’ such activities must be more than transitory or incidental–administrative functions, such as opening brokerage accounts, wiring funds, and bookkeeping activities, would generally not be deemed to be deemed as ‘participating’ in the offering.”

January 23rd, 2014|Dodd-Frank, Educational Series|

Proposed Regulation A rules have bad actor disqualification similar to Rule 506(d)

On December 2, 2013, the U.S. District Court for the Western District of Pennsylvania ruled that a combined disclosure and authorization form that contained a liability waiver which the employer gave to a group of former job applicants violates the Fair Credit Reporting Act (the “FCRA.”) The court determined that a significant portion of the 1,800 individuals in this class action are entitled to willful damages under the FCRA and could each receive the greater of his/her actual damages or $1,000 plus attorneys’ fees.

This is a second published decision to hold that liability waivers invalidate the disclosure requirements under the FCRA. The first ruling rendered in January 2012 in the U.S. District Court in Maryland found that “both the statutory text and FTC advisory opinions indicate that an employer violates the FCRA by including a liability release in a disclosure document.” Thus far, only the U.S. District Court for the Western District of North Carolina disagreed, deciding in August 2012 that the liability waiver included in the defendant employer’s combined disclosure and authorization form was kept sufficiently distinct from the disclosure language so as not to render it ineffective.

January 17th, 2014|Dodd-Frank, Employment Decisions|

Remedying Rule 506 “bad actor” disqualification through reasonable care

The SEC’s Rule 506 “bad actor” amendments went into effect September 23, 2013. As we reported previously, these amendments add Rule 506(d) to implement Regulation 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the rule, securities offerings involving certain “felons and other ‘bad actors'” are disqualified from the Rule 506 exemption unless the disqualification is waived or remedied through a “reasonable care” exception. (See Securities Act Release No. 9414, 78 Fed. Reg. 44,729; July 24, 2013).

The rule’s long list of disqualifying events – and an even longer list of covered persons – is raising consternation as issuers and practitioners come to grips with the challenges of compliance. A disqualification due to the presence of “bad actors” can be catastrophic, resulting in the loss of the exemption altogether, spilling into regulatory actions, litigation, and reputational issues. And any impediment to raising capital is likely to scare away investors.

The rule provides an exception from disqualification if 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. The SEC has not prescribed specific steps to establish reasonable care; however, it has indicated that the concept includes a factual inquiry in view of the particular facts and circumstances and other offering participants. Despite the procedural ambiguity, the message is clear that is not enough to show that the issuer was unaware of the disqualifying event – the issuer must establish that in exercising “reasonable care,” could not have known that a disqualification existed.

In anticipation of this ruling, SI has been including “disqualifying event” searches in many of its reports for over two years. Now that the ruling has gone into effect, SI also offers a specialized factual inquiry service to help our clients evidence “reasonable care” under the highest standards. For information, please contact Dave Lazar at 440-423-1157 or e-mail dlazar@scherzer.co or Jessica Staheli at 818-227-2598 or e-mail jstaheli@scherzer.co.

October 29th, 2013|Dodd-Frank|

Final “bad actor” disqualification ruling long overdue

Over two years ago, Section 926 of the Dodd-Frank Act called for the SEC to impose “bad actor disqualification”(sometimes referred to as “bad boy disqualification”) on Rule 506 private placements. Under the proposed rule, which is long overdue, an issuer may not rely on Rule 506 exemptionfrom registration if certain individuals or entities associated with the offering have a disqualifying event in their past, such as a violation of securities law, state regulatory order or bar, or similar infraction.

Further, the JOBS Act, enacted last year, provided for the SEC to amend Rule 506 to lift the ban on general solicitation. This rulemaking is also past due, and anxious onlookers speculate that these changes to Rule 506 will get finalized at the same time. While there have been many comments to modify some of the rule’s overbroad applications, it is uncertain if the suggested changes will happen.

Notably, there is an important exception to the disqualification provisions. If an issuer exercises “reasonable care” in making a factual inquiry but is unable to uncover the disqualifying events despite having conducted the requisite due diligence, it will not necessarily lose the ability to rely on Rule 506. Although the proposed rules do not provide bright-line tests for establishing due diligence, they clearly point that the issuer has a duty to make a factual inquiry into the existence of disqualifying events. And depending on the circumstances, representations in agreements and questionnaires may not be adequate. Searching public databases also may be required, and possibly “further steps” which have yet to be defined.

SI understands that the bad boy disqualifiers can stop an offering in its tracks immediately upon the final rule’s adoption. And no matter what the transaction, no one wants to be involved with a “bad boy.” For over a year, our proactive approach has been to include comprehensive searches of the disqualifying event elements in higher level background reports as a value-add. The very real risk that issuers could lose the Rule 506 exemption due to facts of which they are not even aware illustrates the power of effective and thorough due diligence.

March 20th, 2013|Dodd-Frank|