Bad Actor Disqualification

Bad actor rules can remove an otherwise available exemption

Several exempt-offering frameworks contain disqualification provisions designed to prevent issuers from relying on the exemption when specified people connected to the offering have serious regulatory, criminal or court histories.^[1]

Rule 506(d) is the best-known example.

The practical consequence is significant: an offering may satisfy investor and transaction requirements yet still lose access to Rule 506 because of a covered person’s disqualifying event.

Who can be a covered person?

The categories depend on the exemption, but Rule 506 analysis can reach beyond the issuer itself.

Covered persons can include certain:

• directors
• executive officers and participating officers
• general partners and managing members
• significant beneficial owners
• promoters
• investment managers
• persons paid for soliciting purchasers
• directors, officers, partners or managing members of compensated solicitors^[1]

The breadth of the list is why private-placement diligence often includes questionnaires and background checks for people involved in the financing.

What can be a disqualifying event?

Examples can include specified:

• felony or misdemeanor convictions
• court injunctions and restraining orders
• SEC disciplinary orders
• certain SEC cease-and-desist orders
• state securities, banking or insurance regulatory orders
• federal banking agency orders
• suspension or expulsion from certain self-regulatory organizations^[1]

The rule contains detailed lookback periods and event-specific requirements.

A headline description of past misconduct is not enough to determine the outcome; the exact order, date, person and legal provision matter.

Reasonable factual inquiry matters

Issuers are expected to conduct a factual inquiry that is reasonable under the circumstances to determine whether disqualifying events exist.^[2][3]

That does not necessarily require the same background-search process in every offering.

The appropriate diligence can depend on:

• the number and role of covered persons
• the issuer’s relationship with them
• available certifications
• public regulatory records
• prior diligence
• transaction size and structure

Some events require disclosure rather than disqualification

The rules distinguish between events that trigger disqualification and certain older events that may instead require written disclosure to investors.

Timing is therefore central.

A prior order can remain relevant even when it does not automatically eliminate the exemption.

Waiver procedures can also exist in appropriate circumstances.^[2]

Common mistakes

“Only the issuer’s criminal history matters.”

No. The covered-person list can extend to officers, owners, promoters and compensated solicitors.

“Any regulatory action creates permanent disqualification.”

No. The rule specifies categories, timing and lookback periods.

“A clean Form D proves there are no bad actors.”

No. Form D is a notice filing, not an SEC determination that the offering qualifies.

“Bad actor rules apply only to Rule 506(c).”

No. Rule 506(b) is also subject to bad actor disqualification, and related frameworks contain their own provisions.

Bad actor analysis is a transaction eligibility test, not merely a reputational check. The most important work is mapping each person to the covered-person definition and each historical event to the exact disqualification rule.