Practical Law Bad Actor Questionnaire

The full text of the SEC press release adopting the bad actor rule is available here. Recognizing the difficulty of obtaining absolute certainty that there are no bad actors involved in an offering, the SEC adopted a Rule 506(d) standard that applies when an issuer was not aware of a bad actor and could not have known even after conducting due diligence. In this case, the issuer has fulfilled its obligations under the new bad actor rule. However, it can be difficult to determine whether an issuer has exercised due diligence because the SEC deliberately left the description of “relevance” vague to account for differences in issuers` circumstances. Prior to this change, the 506 bid rules were silent on bad actors. The new bad actors disqualification now applies to the “old” 506 rule, which is now Rule 506(b) and governs offers that do not involve a general solicitation, and to “new” offers under Rule 506(c), where issuers can generally advertise. The prohibition on bad actors is codified in a new paragraph (d) of Rule 506 and comes into force on September 23, 2013. A “bad actor” is a person, whether a corporation or an individual, who committed one of the securities violations during a specified period prior to the first sale in a 506 offer. A final decision may be appealed.

An order does not have to be indisputable to be a “final order” under the rules for bad actors. Review of the first phase. A review of the first phase could include a questionnaire with a checklist for bad actions and room for explanations. It is important to note that, because it is not reasonable to assume that bad actors always tell the truth, questionnaires alone are not enough. However, they may flag issues for both the data subject and the issuer that warrant further analysis. The objective of the first phase would be to have a short questionnaire with some general questions, rather than simply copying and pasting the entire text of section 506(d) and adding checkboxes. This can lead to false positives, but simplifies the process for everyone involved. For example, “Have you ever been the subject of a state or federal agency order?” will cover many categories of the Bad Act, and the vast majority of respondents will check “no.” For those considering yes, the issuer may also ask if the order comes from a bank or securities regulator and the contents of the order. The next part of the review consists of a search of public records. Most companies hire an external investigator for this purpose. Some of this research needs to be adapted – for example, a reputation check with FINRA may be sufficient for a broker-dealer.

But in general, research should include: Form of disclosure. The Commission expects issuers to attach due importance to disclosure in order to ensure that information on pre-existing events involving malicious actors is adequately presented in the overall mix of information made available to investors. The rules apply only to sales of securities made on or after September 23, 2013. Sales of securities made prior to the effective date of the bad actor provisions are not affected by the exclusion and disclosure requirements, even if these sales are part of an offer that continues after the effective date. Only sales made after the effective date of the amendments will be subject to disqualification and mandatory disclosure. Executives and consultants of a company considering a 506 offer should begin the due diligence process early. If a company expects, even remotely, to make a 506 offer in the future, bad actor due diligence should be an ongoing process built into the comprehensive background checks that are conducted when hiring agents, directors, and contracts with consultants. Equally long is the list of people who fall under the new rule for bad actors, or “covered persons.” Issuers wishing to participate in a 506 offer must conduct certain surveys of all covered persons prior to the first sale of the offer to ensure that no affected person is a bad actor.

In general, issuers are required to conduct this survey of all persons who will reasonably be involved in the offer, including directors; officers and certain other officials; Complementary; executive members; major shareholders; Promoters; and all those who are remunerated under the 506 offer, such as intermediary agents. The investigation of bad actors also extends to directors, officers, general partners and executive members of paid lawyers.