The SEC staff issued new Compliance & Disclosure Interpretations relating to Rule 506(d), the new bad actor rule. Under the rule, an issuer may not rely on the Rule 506 exemption if the issuer or any other person covered by rule has a relevant disqualifying event that occurred on or after September 23, 2013 (the effective date of the rule 506).
It’s a tricky rule, mandated by Dodd-Frank. Conceptually, I agree that the law should not permit bad guys to participate in private offerings of securities. The devil is in the details.
One murky item was what it meant to “participate” in the offering. For a big placement agent or brokerage, it’s easy to wall someone off. But how does that work from the perspective of the issuer? The SEC offered two new answers to questions about “participation.”
Question: Does the term “participating” include persons whose sole involvement with a Rule 506 offering is as members of a compensated solicitor’s deal or transaction committee that is responsible for approving such compensated solicitor’s participation in the offering?
Participation in an offering is not limited to solicitation of investors. Examples of participation in an offering include participation or involvement in due diligence activities or the preparation of offering materials (including analyst reports used to solicit investors), providing structuring or other advice to the issuer in connection with the offering, and communicating with the issuer, prospective investors or other offering participants about the offering. To constitute participation for purposes of the rule, such activities must be more than transitory or incidental. Administrative functions, such as opening brokerage accounts, wiring funds, and bookkeeping activities, would generally not be deemed to be participating in the offering.
Those question are clearly addressed to placement agents and brokers, not to issuers.
So who is “participating” in the offering at a fund manager?
The rule explicitly covers the fund manager. But the fund manager is rarely an individual.
The rule explicitly covers “any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with such sale of securities.” That would cover the marketing group, if any of them are getting paid a commission. Of course that raises the other issuer of whether the marketing group is subject to broker-dealer registration.
The rule also includes any “general partner or managing member of any such investment manager.” Those are legal terms and could be avoided by the organizational structure and titles granted to the manager’s principals. But I would include the principal owners of the fund manager.
Then the rule moves down the next rung and includes “any director, executive officer or other officer participating in the offering of any such investment manager”. The SEC release clearly said that merely being an officer, does not bring you into the scope of the rule’s disqualification. An “officer” test based solely on job title would be unduly burdensome and overly restrictive.
Participation in an offering would have to be more than transitory or incidental involvement, and could include activities such as participation or involvement in due diligence activities, involvement in the preparation of disclosure documents, and communication with the issuer, prospective investors or other offering participants.
That brings the marketing group clearly back into the rule because is communicates with prospective investors.
I have trouble with “preparation of disclosure documents.” Lots of people in the organization help to prepare the disclosure documents and are involved in due diligence activities.
I was hoping the SEC’s new interpretations would help narrow the scope of those covered by the rule at the fund manager. But they do not.