While new Rule 506(c) promises to transform the Regulation D fundraising landscape, there are the so called “bad actor” companion rules that anyone raising money pursuant to 506(c) must pay close attention to. In particular, on July 10, 2013, the U.S. Securities and Exchange Commission (“SEC”) adopted amendments to Rule 506 of the Securities Act of 1933 to disqualify securities offerings relying on the Rule 506 exemption that involve certain “bad actors”. These amendments came into effect on September 23, 2013. As a result, despite the fact 506(c) allows for general solicitation, it does so only if the issuer is compliant with the bad actor rules, among others. For some time, there was confusion as to how these rules were to be applied.
In response to inquiries concerning potential confusion concerning the application of the rules, on December 4, 2013, the SEC posted additional Compliance and Disclosure Interpretations (“CDIs”) to clarify the application of 506(c). The pertinent CDIs range from 260.14 to 260.27. Key CDIs are outlined below.
CDI 260.16 indicates that the “affiliated issuer” definition is circumscribed only to include any affiliate that is issuing securities in the same offering. Accordingly, this has made clear that the term “affiliated issuer” does not extend to every single affiliate of the issuer that has ever issued securities. In the best case, this has allayed concerns that the potential universe of affiliates could be unmanageably large.
Factual Inquiry Clarification
CDI 260.14 states that “an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event”. However, in the event that an offering is “continuous, delayed or long-lived”, the issuer must “periodically” update its factual inquiry regarding “bad actor” triggering events. However, the term “periodically” has been left open ended. In the absence of specific clarification on the meaning of “periodic”, the CID also sets out methods of factual inquiry that may be acceptable, such as questionnaires and certifications as well as periodic re-checking of public databases.
Reasonable Care Exception
CDI 260.23 also provides clarification as to the meaning of the “reasonable care” exception, which “applies whenever the issuer can establish that it did not know and, despite the exercise of reasonable care, could not have known that a disqualification existed under Rule 506(d)(1)”. This CDI clarifies that the exception extends to scenarios where the issuer was unable to determine the existence of a disqualifying event or that a particular person was a covered person. It also applies where the issuer makes an initial determination that a person may not have been covered, but then ultimately realized such determination was erroneous. Hence, the SEC has not further clarified its position that a determination of whether “reasonable care” was undertaken by an issuer is to be determined on a case-by-case basis.