Weeding out the Bad Actors

On the infamous day in July when the SEC loosened the reins on general solicitation and proposed related new rules and rule amendments, the SEC also finalized the “bad actor” disqualification rules for most private placements (as required by the 2010 Dodd-Frank Act).


Essentially, pursuant to new Rule 506(d)), if a “covered person” under the rule engages in a bad act after the effective date, a fund in any offering will not be able to engage under Rule 506. If the bad act happened prior to the effective date, the bad act will need to be disclosed to investors in order for the private fund to be offered under Rule 506. In a notable addition to the definition of “covered persons” found in the proposed rules, such persons now include the directors, executive officers, other officers participating in the offering, and general partners and managing members of investment managers of pooled investment funds.

Due diligence will be necessary in order to avoid potential disqualification. Here are some suggestions to consider:

  • Be sure to include a pre-screening process where new employees make written representations that they have not had any disqualifying event. Have them fill out a questionnaire with relevant certifications.
  • Circulate questionnaires to existing employees asking whether they participated in a disqualifying event in the past. As mentioned above, if such employees committed a “bad act” as defined in the new rule, this fact should be disclosed to investors (but the offering can continue) .
  • Review selling agreements and placement agent agreements and be sure to include necessary assertions.
  • Use extra care and diligence during corporate mergers.
  • Implement strong policies and procedures illustrating the firm’s reasonable care and related controls to avoid hiring persons with disqualifying events.

These compliance measures should be completed prior to September 23 when the rules will become effective.

For more see: http://www.sec.gov/rules/final/2013/33-9414.pdf