Today, after too lengthy a delay, the Commission implements the Dodd-Frank mandate to disqualify felons and certain other bad actors from participating in unregistered offerings under Rule 506 of Regulation D.1 Limiting felons and bad actors from participating in Rule 506 offerings is simply the right thing to do, and I support the amendments to Rule 506.
However, the Bad Actor Rule before us today is by no means perfect. The most glaring weakness is that the Bad Actor Rule will only apply to those that are disqualified in the future. In other words, a Bad Actor will only be disqualified if the event that triggers disqualification occurs after the effective date of the rule. Given that the effective date is in the future — that is, 60 days after publication in the Federal Register — what does this mean? It means that everyone who triggers the bad actor definition prior to sometime in September 20132 is free to participate in Rule 506 offerings on a going forward basis.
I do not believe that Congress intended to limit bad actor disqualification to such a great extent. Moreover, it is particularly disappointing that the Commission allowed this rule to languish for more than two years, while all too many "bad actors" received court orders or other sanctions that could have — but, now, will not — disqualify them from taking advantage of Rule 506 for years to come.
In addition, the adopting release makes a number of changes to the proposal that will limit the reach of the Bad Actor Rule. For example, the proposal applied the disqualification triggers to any officer of the issuer or any officer of a person paid to solicit investors; in contrast, the final rule covers only executive officers of such entities and officers who participate in the offering. Similarly, the proposal applied the triggers to any beneficial owner of 10% or more of any class of the issuer´s securities; in contrast, the final rule covers only beneficial owners of securities representing 20% or more of the issuer´s total voting power. I also believe that the look-back period for court injunctions, Commission cease-and-desist orders, and other disqualification orders should have been ten years, rather than five.
However, notwithstanding the significant narrowing of the disqualification, it is important to take steps to limit the potential abuse of Rule 506. That is particularly true as a result of the Commission´s concurrent adoption of a deficient regime allowing general solicitation in Rule 506 offerings.3 Rule 506 is the most widely used exemption for offerings under Regulation D. Companies and investment funds raise almost as much money each year using Rule 506 as they do in registered public offerings. But, as is well known, investors in Rule 506 offerings have substantially fewer protections than investors in public offerings. Accordingly, it makes sense to limit the ability of individuals and entities with a record of fraud or dishonesty, or who have disregarded regulatory requirements, to take advantage of the Rule 506 exemption.
As adopted, the Bad Actor Rule will help protect investors in a number of ways:
First, the rule requires companies and investment managers to exercise due diligence in Rule 506 offerings to ensure that executive officers and other key offering participants are not disqualified under the rule. I expect for issuers utilizing Rule 506 to develop effective vetting procedures to keep the bad apples from harming investors.
Second, the Bad Actor Rule provides the Commission with an additional enforcement tool to protect investors from fraudsters and other recidivists who seek to use Rule 506. Disqualifying bad actors from using Rule 506 should also strengthen the hand of state securities regulators, since offerings that comply with Rule 506 are exempt from the registration and qualification requirements of state securities laws.4
My support for the Bad Actor Rule is tempered by my belief that it should be stronger. Nonetheless, I appreciate the efforts of the staff on this rule.
1 Dodd-Frank Wall Street Reform and Consumer Protection Act, §926. Pub. L. No. 111-203, § 926, 124 Stat. 1376, 1851 (July 21, 2010) (codified at 15 U.S.C. 77d note).
2 The rule is effective 60 days after publication in the Federal Register. Disqualification of Felons and Other "Bad Actors" from Rule 506 Offerings, Release No. 33-[XXXX] (July 10, 2013).
3 Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-[XXXX] (July 10, 2013). See, Luis A. Aguilar, "Facilitating General Solicitation at the Expense of Investors," Statement at SEC Open Meeting (July 10, 2013).
4 See, Securities Act of 1933, §18.