Regulatory and Compliance
Bad Actors for Rule 506 Offerings
Jul 28, 2023
Each year, thousands of businesses and investment funds raise billions of dollars in capital, through unregistered offerings under Rule 506 - the most widely used exemption under Regulation D of the Securities Act of 1933, as amended.
Most Regulation D offerings are relatively small, but the aggregate amount of capital raised in these offerings rivals the registered public offering market.
In 2013, as mandated by the Dodd-Frank Act, the SEC amended Rule 506 to prohibit issuers from relying on that exemption if the issuer or another covered person has been convicted of, or is subject to judicial or regulatory sanctions for certain violations of law.
This amendment, known as the Bad Actor Rule, became effective September 23, 2013.
What are Bad Actor Checks and why do I need them?
If you’re raising money under Rule 506 of Regulation D, your offering is subject to SEC rules. Under the SEC’s rules, there are certain rules that disqualify individuals from raising money. Most of these rules relate to securities related violations.
Bad Actor Checks (BAC's) are an essential part of the due diligence process for companies seeking to raise money under Rule 506 of Regulation D of the Securities Act of 1933, as amended. The purpose of these checks is to ensure that the offering is not being conducted by individuals or entities that are considered "bad actors" by the Securities and Exchange Commission (SEC).
A "bad actor" is someone who has been involved in certain specified legal or regulatory violations related to securities. The SEC has put these rules in place to protect investors from potential fraudulent activities and to maintain the integrity of the capital markets.
When a company intends to make an offering of securities under Rule 506, they must conduct a thorough investigation to determine if any covered persons involved in the offering have a history that could disqualify them from relying on the Rule 506 exemption. Covered persons include the company, its directors, officers, general partners, and other individuals involved in the offering.
The bad actor disqualification rules under Rule 506 are primarily intended to prevent companies or individuals with a history of securities law violations from taking advantage of the exemption. If any covered person falls under any of the disqualifying events, the company may lose the ability to rely on the Rule 506 exemption and may be barred from conducting the offering.
To comply with the bad actor provisions, companies are required to perform reasonable diligence, including making inquiries of covered persons, to determine if any disqualifying events apply. This involves conducting background checks and obtaining representations from covered persons about their history and compliance with securities laws. The checks must be performed within a specified time frame before the offering is made.
Types of Rule 506 Offerings
It's important to note that there are two different types of Rule 506 offerings: Rule 506(b) and Rule 506(c). The bad actor provisions apply to both types, but the verification requirements for investors differ between the two.
Under Rule 506(b), companies can sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors, but they cannot use general solicitation or advertising to market the offering.
Under Rule 506(c), general solicitation and advertising are allowed, but all investors must be verified as accredited investors.
Who do I need BAC's for?
Under the rules, Bad Actor Checks are required for every “covered person” involved in the campaign. The SEC defines “covered persons” to include the following:
Disqualifying Events
Under the final rule, disqualifying events include:
SEC Compliance Guide https://www.sec.gov/info/smallbus/secg/bad-actor-small-entity-compliance-guide
About Capital Engine®
Capital Engine® provides forward-thinking organizations with efficient and scalable private capital and investor management solutions, for both traditional and digital assets.
Built for high-performance capital raising, our technology helps leverage the opportunity to better originate and showcase a diverse selection of private investment deals and offer these to investors i.e. a deal’s potential viability can be better assessed, market appetite determined and transaction promptly closed.
Our clients include broker dealers, family offices, wealth managers, incubators, accelerators, social impact and real estate funds, in providing customized SaaS solutions to power private capital and alternative investment platforms, with a strong focus on investor management services.
Interested in raising capital
Request a Call / Demo
Most Regulation D offerings are relatively small, but the aggregate amount of capital raised in these offerings rivals the registered public offering market.
In 2013, as mandated by the Dodd-Frank Act, the SEC amended Rule 506 to prohibit issuers from relying on that exemption if the issuer or another covered person has been convicted of, or is subject to judicial or regulatory sanctions for certain violations of law.
This amendment, known as the Bad Actor Rule, became effective September 23, 2013.
What are Bad Actor Checks and why do I need them?
If you’re raising money under Rule 506 of Regulation D, your offering is subject to SEC rules. Under the SEC’s rules, there are certain rules that disqualify individuals from raising money. Most of these rules relate to securities related violations.
Bad Actor Checks (BAC's) are an essential part of the due diligence process for companies seeking to raise money under Rule 506 of Regulation D of the Securities Act of 1933, as amended. The purpose of these checks is to ensure that the offering is not being conducted by individuals or entities that are considered "bad actors" by the Securities and Exchange Commission (SEC).
A "bad actor" is someone who has been involved in certain specified legal or regulatory violations related to securities. The SEC has put these rules in place to protect investors from potential fraudulent activities and to maintain the integrity of the capital markets.
When a company intends to make an offering of securities under Rule 506, they must conduct a thorough investigation to determine if any covered persons involved in the offering have a history that could disqualify them from relying on the Rule 506 exemption. Covered persons include the company, its directors, officers, general partners, and other individuals involved in the offering.
The bad actor disqualification rules under Rule 506 are primarily intended to prevent companies or individuals with a history of securities law violations from taking advantage of the exemption. If any covered person falls under any of the disqualifying events, the company may lose the ability to rely on the Rule 506 exemption and may be barred from conducting the offering.
To comply with the bad actor provisions, companies are required to perform reasonable diligence, including making inquiries of covered persons, to determine if any disqualifying events apply. This involves conducting background checks and obtaining representations from covered persons about their history and compliance with securities laws. The checks must be performed within a specified time frame before the offering is made.
Types of Rule 506 Offerings
It's important to note that there are two different types of Rule 506 offerings: Rule 506(b) and Rule 506(c). The bad actor provisions apply to both types, but the verification requirements for investors differ between the two.
Under Rule 506(b), companies can sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors, but they cannot use general solicitation or advertising to market the offering.
Under Rule 506(c), general solicitation and advertising are allowed, but all investors must be verified as accredited investors.
Who do I need BAC's for?
Under the rules, Bad Actor Checks are required for every “covered person” involved in the campaign. The SEC defines “covered persons” to include the following:
- the issuer, including its predecessors and affiliated issuers;
- directors, general partners, and managing members of the issuer;
- executive officers of the issuer, and other officers of the issuers that participate in the offering;
- 20% beneficial owners of the issuer, calculated on the basis of total voting power;
- promoters connected to the issuer;
- for pooled investment fund issuers, the fund’s investment manager and its principals; and
- persons compensated for soliciting investors, incl. their directors, general partners and managing members
Disqualifying Events
Under the final rule, disqualifying events include:
- Certain criminal convictions
- Certain court injunctions and restraining orders
- Final orders of certain state and federal regulators
- Certain SEC disciplinary orders
- Certain SEC cease-and-desist orders
- SEC stop orders and orders suspending the Regulation A exemption
- Suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or from association with an SRO member
- U.S. Postal Service false representation orders
SEC Compliance Guide https://www.sec.gov/info/smallbus/secg/bad-actor-small-entity-compliance-guide
About Capital Engine®
Capital Engine® provides forward-thinking organizations with efficient and scalable private capital and investor management solutions, for both traditional and digital assets.
Built for high-performance capital raising, our technology helps leverage the opportunity to better originate and showcase a diverse selection of private investment deals and offer these to investors i.e. a deal’s potential viability can be better assessed, market appetite determined and transaction promptly closed.
Our clients include broker dealers, family offices, wealth managers, incubators, accelerators, social impact and real estate funds, in providing customized SaaS solutions to power private capital and alternative investment platforms, with a strong focus on investor management services.
Interested in raising capital
Request a Call / Demo
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