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Regulation 506(d) and Accounting for ‘Bad Actors’

Mihir Gandhi

Put into regulation by way of the Jumpstart our Business Startups Act (JOBS Act), Regulation 506(d) was designed to prevent certain “bad actors”, and companies associated with them, from certain methods of raising capital, including various forms of crowdfunding.

Who’s Covered?
The bad actor disqualifications under Rule 506(d) make Rule 506 unavailable if an issuer or specified “covered persons” committed the bad acts listed in Rule 506(d). Covered persons include the issuer itself, individuals who control the issuer, beneficial owners - individuals or companies that control 20% or more of the issuer’s voting securities, and individuals and companies associated with the offering.

What Constitutes Bad Actor Actions?
The bad acts generally fall into the following categories:

  • Convictions for crimes – either felonies or misdemeanors – involving securities
  • Court orders or decrees that bar the covered person from specific activities involving securities
  • Orders of state and federal banking, insurance and commodities regulators
  • SEC orders that prohibit a covered person from engaging in specified business activities or order a person to stop committing fraud or illegal offerings
  • Expulsion from membership in a securities exchange or a national securities association for failing to follow just and equitable principles of trade
  • Making or underwriting a registered offering that was stopped or suspended by the SEC, or is currently the subject of investigations or proceedings for a stop order or suspension.
  • Orders of the U.S. Postal Service related to false representations (i.e., mail fraud).

The Silver Lining
So what happens if a bad actor is uncovered? It’s not great. An issuer that has – even unknowingly - engaged a bad actor as an officer or director, has a bad actor directly or indirectly owning a large amount of shares, or engages a bad actor to solicit investors, could embroil the company and otherwise blameless officers and directors in the criminal enterprise of an illegal securities offering. If there’s any silver lining, it’s that the issuer could show that it did not know of the disqualification and, in the exercise of reasonable care, could not have known that a disqualification existed.

Complying With Regulation 506
Rule 506 is important because it’s the single most used method of capital raising by private companies. But it isn’t all about bad actors. The core of Rule 506 is subsections (b) and (c). Rule 506 is primarily centered around subsections (b) and (c) which provide the rules for raising capital. Rule 506(c), in particular, is currently the industry darling as it is seen as the main vehicle that can be used for crowdfunding.

Rule 506(c) requires verification of investors as accredited investors. can help you get started. Visit us for more information today.