Rule 506 Exemption
Rule 506 of Regulation D of the Securities Act of 1933 is an exemption from the registration requirements of the Securities Act for certain private securities offerings. This rule allows issuers to raise an unlimited amount of capital from an unlimited number of accredited investors, and up to 35 non-accredited investors.
Under Rule 506(b), issuers must take reasonable steps to verify that their investors are accredited. This means that issuers must review the investor’s income or net worth, and obtain written representations from the investor that they are accredited.
Rule 506(c) allows issuers to use general solicitation or advertising for marketing the securities, provided that they take reasonable steps to verify that all purchasers of the securities are accredited investors.
Rule 506 is a “safe harbor” provision, meaning that if an issuer meets the requirements of the rule, they will be deemed to comply with the registration requirements of the Securities Act. However, issuers should be aware that they may still be subject to liability for fraud, misrepresentations or other violations of the securities laws.
Bad Actor Rule
The bad actor rule of Rule 506(d) of the securities laws is a provision that disqualifies certain issuers from using the safe harbor provided by Rule 506 of Regulation D of the Securities Act of 1933. The rule is intended to protect investors by preventing issuers with a history of securities law violations from using the exemption provided by Rule 506.
The rule applies to any “covered person,” which includes the issuer, any predecessor of the issuer, any affiliated issuer, any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer, any beneficial owner of 20% or more of the issuer’s outstanding voting equity securities, any promoter connected with the issuer in any capacity at the time of sale, and any compensated solicitor or finder.
The rule disqualifies an issuer from using the exemption provided by Rule 506 if any covered person has a “disqualifying event,” which includes any conviction, court injunction, or final order for certain securities law violations, as well as certain regulatory and administrative actions. The rule also disqualifies an issuer if any covered person is subject to certain types of disqualification by the SEC, such as being a “bad actor” under Section 9(a) of the Investment Company Act of 1940.
The bad actor rule of Rule 506(d) has been the subject of several court cases, including SEC v. Scoville, which involved an issuer that had been subject to a cease and desist order by the SEC for making false and misleading statements in connection with a securities offering. The court held that the issuer was not eligible to use the exemption provided by Rule 506, as the issuer’s conduct constituted a “disqualifying event” under the bad actor rule.
In addition, there have been several cases interpreting the scope of the rule and its application to specific types of conduct, such as SEC v. Kelly, which involved an issuer whose CEO had been convicted of securities fraud. The court held that the CEO’s conviction was a “disqualifying event” under the bad actor rule, as it involved a violation of the securities laws.
Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.