Bad Actor Checks for Private Placements: Who to Check and What to Look For

Rule 506(d) takes away Rule 506 protection if certain bad actors are involved in the offering. The check covers a defined list of people connected to the issuer and its solicitors, and the disqualifying events are criminal convictions, fraud injunctions, certain regulator orders, and bars or suspensions, each inside a look-back window. The failure mode is quiet: the offering closes, nobody ran the check, and the exemption everyone assumed applied never did.

Investors who were sold shares in an offering that lost Rule 506 protection can have rescission rights, meaning a right to get their money back. That is why this check belongs at the start of every placement, not in the cleanup file.

Who Is Covered

The list is broader than most issuers expect. Covered persons are:

• The issuer, plus any affiliated issuers and the issuer's predecessors.
• Every director and executive officer, and their equivalents at the general partner or managing member.
• Promoters compensated for promoting the offering.
• Beneficial owners of 20 percent or more of the issuer's voting securities.
• Every compensated solicitor, such as a placement agent, and the directors, executive officers, and 20 percent owners of that solicitor.

A promoter with a decade-old problem, a placement agent's principal, or a new 20 percent investor who arrives mid-offering all count. The list moves as the deal moves, which is part of why the check belongs in every closing checklist, not just the first one.

What Disqualifies

The disqualifying events fall into a few buckets, each with its own look-back:

• Criminal convictions in a securities or fraud matter within 10 years for felonies and 5 years for misdemeanors.
• Court injunctions against securities law violations or false filings within 5 years.
• Final orders from state securities, insurance, or financial institution regulators, and certain federal commodity regulators, within 10 years where the order involves fraudulent or deceptive conduct.
• Bars or suspensions from association with regulated entities: broker-dealers, investment advisers, accountants, attorneys, and others.
• SEC stop orders on registration statements, and post-effective order suspensions, within 5 years.

The full rule runs longer, and the exceptions matter in real cases. Matching a specific person's history against the rule is lawyer work. What an issuer needs to internalize is the shape of it: certain people, certain events, certain windows.

Timing and the Grandfather Rule

Disqualification only reaches events on or after September 23, 2013, when the rule took effect. Older events are grandfathered, unless the covered person was still subject to a court or regulatory action arising from the event after that date. So an otherwise disqualifying event from 2009 usually does not reach today's offering. "Usually" is carrying weight in that sentence, which is why the answer for a specific person is a records check, not a shrug.

Whose Job Is the Check

The issuer's, always. In practice the diligence is split. Compensated solicitors must make a factual inquiry into whether they and their covered persons have disqualifying events, before they get paid, and the issuer is expected to collect that diligence. For issuer-side persons, the SEC expects the issuer to establish facts reasonably: questionnaires, representations, and a reasonable investigation proportionate to the risk.

What "reasonable" means scales with facts. A small private company doing a friends-and-family round documents one level of diligence. An issuer using a commissioned sales force documents another. In every version, the file is the defense: if a problem surfaces later, the question becomes whether the issuer reasonably did not know and could not have known. Undocumented diligence is indistinguishable from no diligence.

How the Check Runs in Practice

A workable process looks like this:

• A questionnaire for every covered person, refreshed at each closing and at least annually for long-running offerings.
• Public records searches: SEC litigation releases and administrative orders, FINRA BrokerCheck, state regulator databases, court records in relevant jurisdictions.
• Diligence files from every compensated solicitor.
• A short memo to the deal file recording what was checked and when, so the record exists.

When the Check Finds Something

A disqualifying event does not automatically end the offering. First, confirm it actually is disqualifying: the event has to fit a bucket and sit inside the look-back window, and many do not. Second, if it is disqualifying and the person cannot be removed from the deal, the SEC requires disclosure to investors when the event is known before they purchase. Third, a waiver can be sought from the SEC staff, and experienced counsel can tell you quickly whether that path is realistic.

What is not on the menu is quietly proceeding without the check. That is how a placement becomes an unregistered offering with rescission exposure, and how enforcement matters start years later.