Private Placements and Bad Actors

More and more questions are popping up on FINRA Exams concerning disqualifying events which prohibit certain bad actors from participating in private placement offerings.

With the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act,  certain “bad actors” are precluded from participating in offerings under Regulation 506. If any covered person has been the subject of a disqualifying  event on or after September 23, 2013, the offering may not rely on an exemption under Regulation 506. Covered persons for this rule include:

  1. The issuer itself including any predecessors or affiliated issuers
  2. Directors, general partners and managing members of the issuer
  3. Executive officers of the issuer and other officers participating in the offering
  4. Any owner of 20% or more of the issuer’s voting stock
  5. Promoters connected to the issuer
  6. Fund investment managers and principal
  7. Any entity compensated for promoting or soliciting investors, including their directors, general partners and managing members

If any person or entity listed above is subject to a disqualifying event, an offering may not take place under Regulation 506 unless an exemption is available through proper disclosure.  A disqualifying event is any of the following:

  1. A criminal conviction in relation to the purchase or sale of a security
  2. A criminal conviction in relation to making false statements to the SEC
  3. A criminal conviction in relation  to operating as an underwriter, broker, dealer, Municipal Securities dealer, investment advisor, or paid solicitor
  4. A U.S. Postal Service order relating to false representations Within the last 5 years 
  5. Fnal orders  barring the individual by state regulators of securities, Insurance, banking, savings associations or credit unions
  6. Final orders  barring the individual by federal banking agencies, the Commodity Futures Trading Commission, FINRA or the New York Stock Exchange 
  7. SEC orders that suspend, limit or revoke the person’s registration as a broker, dealer, municipal securities dealer or investment advisor 
  8. A court injunction or restraining order in connection with the sale of a security
  9. A court injunction or restraining order in  connection with making false filings with the SEC
  10.  A court injunction restraining order regarding the conduct of an underwriter, broker, dealer, Municipal Securities dealer, investment advisor or paid solicitor of  securities

Only those  disqualifying events occurring after September 23, 2013 impact the offering. If the covered person was subject to a disqualifying event prior to that time, it only needs to be disclosed to potential investors and will not impact the availability of an exemption under Regulation 506. The rule provides for a reasonable care exception from disqualification, if the issuer is able to demonstrate that it did not know, and could not have reasonably known, that a covered person with a disqualifying event participated in the offering. Additionally, an issuer who is aware of a disqualifying event impacting a covered person may apply for a waiver to allow the offering to go forward even in light of the disqualifying event impacting the covered person. If a disqualifying event takes place during the offering of securities, the previous sales of securities will not be impacted, but future sales may not take place under regulation 506 unless the disqualifying event is waived or removed.  If the issuer is unaware of the disqualifying event taking place during the offering period, the issuer may be able to rely on a reasonable care exception. Should the SEC issue a cease-and-desist order against a covered person that prohibits a covered person from committing a future violation, the order will only serve as a disqualifying event if issued within 5 years of the proposed sale. Further, only orders that remain in effect will be deemed to be disqualifying events. For example, A person who was barred indefinitely has the right to reapply for association after three years have passed. Should that person be permitted to reassociate, in a regulated capacity, the bar will have ended and the individual will no longer be subject to a disqualifying event. 

Failure to Comply

SEC Rule 508 states that an insignificant deviation from a term or condition required under rule 504  or 506 will not result in the loss of the exemption provided under the rule so long as the person relying on the exemption can demonstrate the following:

  1. That the failure to comply did not relate to  any term or condition designed to protect an individual or entity; and
  2. That the failure was insignificant with respect to the offering as a whole; and
  3. All parties to the offering made a good-faith attempt to comply with all of the rules of 504 or 506  

We hope this article has helped you understand the impact of disqualifying events for certain bad actors.

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 Good luck on your exam!

 The Securities Institute of America

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