Disqualification of Felons and Other “Bad Actors” From Rule 506 Offerings

Federal RegisterJul 24, 2013

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200, 230, and 239

[Release No. 33-9414; File No. S7-21-11]

RIN 3235-AK97

Disqualification of Felons and Other “Bad Actors” From Rule 506 Offerings

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

We are adopting amendments to our rules to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 926 requires us to adopt rules that disqualify securities offerings involving certain “felons and other `bad actors'” from reliance on Rule 506 of Regulation D. The rules must be “substantially similar” to Rule 262 under the Securities Act, which contains the disqualification provisions of Regulation A under the Securities Act, and must also cover matters enumerated in Section 926 of the Dodd-Frank Act (including certain state regulatory orders and bars).

DATES:

Effective Date:

September 23, 2013.

Comment Date:

Comments regarding the collection of information requirements within the meaning of the Paperwork Reduction Act of 1995 should be received on or before August 23, 2013.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form

(

http://www.sec.gov/rules/final.shtml

);

• Send an email to

rule-comments@sec.gov

• Please include File Number S7-21-11 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the

instructions for submitting comments.

Paper Comments

• Send paper comments on the Paperwork Reduction Act analysis in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-21-11. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/final.shtml

). Comments will also be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Johanna Vega Losert, Special Counsel, Karen C. Wiedemann, Attorney Fellow, or Gerald J. Laporte, Office Chief, Office of Small Business Policy, Division of Corporation Finance, at (202) 551-3460, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-3628.

SUPPLEMENTARY INFORMATION:

We are adopting amendments to Rules 145,

147,

152

and 155;

Rules 501

and 506

of Regulation D;

and Form D

under the Securities Act of 1933

and to Rule 30-1

of our Rules of Organization and Program Management.

17 CFR 230.145.

17 CFR 230.147.

17 CFR 230.152.

17 CFR 230.155.

17 CFR 230.501.

17 CFR 230.506.

17 CFR 230.500 through 230.508.

17 CFR 239.500.

15 U.S.C. 77a

et seq.

17 CFR 200.30-1.

Table of Contents

I. Background And Summary

II. Discussion of the Final Amendments

A. Introduction

B. Covered Persons

C. Disqualifying Events

1. Criminal Convictions

2. Court Injunctions and Restraining Orders

3. Final Orders of Certain Regulators

4. Commission Disciplinary Orders

5. Certain Commission Cease-and-Desist Orders

6. Suspension or Expulsion from SRO Membership or Association with an SRO Member

7. Stop Orders and Orders Suspending the Regulation A Exemption

8. U.S. Postal Service False Representation Orders

D. Reasonable Care Exception

1. Reasonable Care Standard

2. Continuous and Long-Lived Offerings

E. Waivers

1. Waiver for Good Cause Shown

2. Waiver Based on Determination of Issuing Authority

F. Transition Issues

1. Disqualification Applies Only to Triggering Events That Occur After Effectiveness of the Rule Amendments

2. Mandatory Disclosure of Triggering Events That Pre-Date Effectiveness of the Rule

3. Timing of Implementation

G. Amendment to Form D

III. Paperwork Reduction Act

A. Background

B. Burden and Cost Estimates Related to the Adopted Amendments

IV. Economic Analysis

A. Background and Summary of the Rule Amendments

B. Economic Baseline

1. Capital Raising Activity Using Rule 506

2. Affected Market Participants

A. Issuers

B. Investors

C. Investment Managers

D. Broker-Dealers

3. Estimated Incidence of “Bad Actors” in Securities Markets Generally

C. Analysis of Final Rules

1. Effects of the Statutory Mandate

2. Discretionary Amendments

V. Final Regulatory Flexibility Act Analysis

A. Reasons for, and Objectives of, the Action

B. Significant Issues Raised By Public Comments

C. Small Entities Subject to the Rule Amendments

D. Reporting, Recordkeeping and Other Compliance Requirements

E. Duplicative, Overlapping or Conflicting Federal Rules

F. Significant Alternatives

VI. Statutory Authority and Text of Amendments

I. Background and Summary

Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), entitled “Disqualifying felons and other `bad actors' from Regulation D offerings,” requires the Commission to adopt rules to disqualify certain securities offerings from reliance on Rule 506 of Regulation D.

The Commission proposed rule amendments to implement Section 926 of the Dodd-Frank Act on May 25, 2011.

Today we are adopting amendments to Rules 501 and 506 and to Form D to implement Section 926. The disqualification provisions we are adopting, to be codified as new paragraph (d) of Rule 506,

are generally consistent with the proposal, but will apply only to triggering events occurring after effectiveness of the rule amendments (with pre-existing events

subject to mandatory disclosure) and also reflect some changes in response to comments.

Public Law 111-203, sec. 926, 124 Stat. 1376, 1851 (July 21, 2010) (codified at 15 U.S.C. 77d note).

See Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings,

Release No. 33-9211 (May 25, 2011) [76 FR 31518 (June 1, 2011)].

Because of the adoption of new Rule 506(c), the disqualification provisions we adopt today, which were proposed as Rule 506(c), will be adopted and codified as Rule 506(d).

Rule 506 is one of three exemptive rules for limited offerings under Regulation D.

It is by far the most widely used Regulation D exemption, accounting for an estimated 90% to 95% of all Regulation D offerings

and the overwhelming majority of capital raised in transactions under Regulation D.

Rule 506 permits sales of an unlimited dollar amount of securities to be made without Securities Act registration, provided that the requirements of the rule are satisfied.

The others are Rule 504 and Rule 505, 17 CFR 230.504 and 230.505. Rule 504 permits offerings of up to $1 million of securities by issuers that are not (i) reporting companies under the Securities Exchange Act of 1934, (ii) investment companies or (iii) development stage companies with no specific business plan or purpose, or whose business plan is to engage in a merger or acquisition with an unidentified entity or entities. Offerings under Rule 504 must generally comply with Regulation D requirements regarding limitations on manner of sale (no general solicitation) and limitations on resale. The manner of sale and resale limitations do not apply, however, to offerings that are subject to state-level registration or that rely on state law exemptions permitting general solicitation so long as sales are made only to accredited investors. Rule 505 permits offerings of up to $5 million of securities annually, without general solicitation, to an unlimited number of accredited investors and up to 35 non-accredited investors. Rule 505 offerings are subject to the same conditions as apply to Rule 506 offerings, which are described elsewhere, except that non-accredited investors are not required to be sophisticated and such offerings are subject to bad actor disqualification provisions.

In 2012, the Commission received 18,187 initial filings for offerings under Regulation D, of which 17,203 (approximately 95%) claimed a Rule 506 exemption.

Staff of the Commission's Division of Economic and Risk Analysis estimates that, for 2009, 2010, 2011 and 2012, approximately $607 billion, $1.003 trillion, $850 billion and $899 billion, respectively, was raised in transactions claiming the Rule 506 exemption, in each case representing more than 99% of funds raised under Regulation D for the period, based on Form D filings with the Commission. The amount of capital raised through offerings under Regulation D and the number of Regulation D offerings may be considerably larger than what is disclosed in Form D filings because the filing of a Form D notice is a requirement of Rule 503(a) of Regulation D [17 CFR 230.503(a)], but is not a condition to the availability of the exemptions of Regulation D. We understand that some issuers, therefore, may not make Form D filings for offerings made in reliance on Regulation D. Further, once a Form D filing is made, the issuer is not required to file an amendment to reflect a change that occurs after the offering terminates or a change that occurs solely with respect to certain information, such as the amount sold in the offering. For example, if the amount sold does not exceed the offering size by more than 10% or the offering closes before a year has passed, the filing of an amendment to Form D would not necessarily be required. Therefore, the Form D filings for an offering may not reflect the total amount of securities sold in the offering in reliance on the exemption.

Rule 506 historically has permitted sales to an unlimited number of accredited investors

and up to 35 non-accredited investors, so long as there was no general solicitation, appropriate resale limitations were imposed, any applicable information requirements were satisfied, and the other conditions of the rule were met.

Section 201(a) of the Jumpstart Our Business Startups Act (“JOBS Act”) required the Commission to eliminate the prohibition against general solicitation and general advertising for offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify their accredited investor status.

In a separate release today, we are adopting amendments to Rule 506 and Form D, including adding new paragraph (c) to Rule 506 to implement JOBS Act Section 201(a).

As a result, offers and sales of securities involving the use of general solicitation will be permitted under Rule 506, provided that the requirements of new Rule 506(c) are satisfied.

Rule 501 of Regulation D lists eight categories of “accredited investor,” including entities and natural persons that meet specified income or asset thresholds.

See

17 CFR 230.501.

Except as provided under new Rule 506(c), offerings under Rule 506 are subject to all the terms and conditions of Rules 501 and 502, including applicable limitations on the manner of offering, limitations on resale and, if securities are sold to any non-accredited investors, specified information requirements. Where securities are sold only to accredited investors, the information requirements do not apply.

See

17 CFR 230.502 and 230.506. In addition, any non-accredited investors must satisfy the investor sophistication requirements of Rule 506(b)(2)(ii). Offerings under Rule 506 must also comply with the notice of sale requirements of Rule 503.

See

17 CFR 230.503.

See

Public Law 112-106, sec. 201(a), 126 Stat. 306, 313 (Apr. 5, 2012).

Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings,

Release No. 33-9415 (July 10, 2013).

“Bad actor” disqualification requirements, sometimes called “bad boy” provisions, disqualify securities offerings from reliance on exemptions if the issuer or other relevant persons (such as underwriters, placement agents and the directors, officers and significant shareholders of the issuer) have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws. Rule 506 in its current form does not impose any bad actor disqualification requirements.

In addition, because securities sold under Rule 506 are “covered securities” under Section 18(b)(4)(D) of the Securities Act, state-level bad actor disqualification rules do not apply.

Rule 507 of Regulation D imposes a different kind of disqualification specific to Regulation D offerings. Under Rule 507, any person that is subject to a court order, judgment or decree enjoining such person for failure to file the notice of sale on Form D required under Rule 503 is disqualified from relying on Regulation D. 17 CFR 230.507(a). We are not amending Rule 507 at this time but, in a separate release the Commission is issuing today, we are proposing amendments to Rule 507 that would disqualify an issuer from reliance on Rule 506 if the issuer or its predecessor or affiliates had conducted a previous securities offering in reliance on Rule 506 without complying with the Form D filing requirements of Rule 503.

See Amendments to Regulation D, Form D, and Rule 156,

Release No. 33-9416 (July 10, 2013).

See

15 U.S.C. 77r(b)(4)(D). This provision of Section 18 was added by Section 102(a) of the National Securities Markets Improvement Act of 1996, Pub. L. No. 104-290,110 Stat. 3416 (Oct. 11, 1996) (“NSMIA”). NSMIA preempts state registration and review requirements for transactions involving “covered securities,” which include securities offered or sold in transactions that are exempt from registration under Commission rules or regulations issued under Securities Act Section 4(a)(2) (formerly Section 4(2)). Rule 506 was originally adopted as a safe harbor under Section 4(a)(2). Section 201(a) of the JOBS Act provides that Rule 506, as amended in accordance with the mandate of that provision, “shall continue to be treated as a regulation issued under” Section 4(a)(2) of the Securities Act.

Section 926 of the Dodd-Frank Act instructs the Commission to issue disqualification rules for Rule 506 offerings that are “substantially similar” to the bad actor disqualification provisions contained in Rule 262 of Regulation A,

and also provides an expanded list of disqualifying events, including certain actions by state regulators, enumerated in Section 926. The disqualifying events listed in Rule 262 cover the issuer and certain other persons associated with the issuer or the offering, including: issuer predecessors and affiliated issuers; directors, officers and general partners of the issuer; beneficial owners of 10% or more of any class of the issuer's equity securities; promoters connected with the issuer; and underwriters and their directors, officers and partners. Rule 262 disqualifying events include:

17 CFR 230.262. Regulation A (17 CFR 230.251 through 230.263) is a limited offering exemption that permits public offerings of securities not exceeding $5 million in any 12-month period by companies that are not required to file periodic reports with the Commission. Regulation A offerings are required to have an offering circular containing specified information, which is filed with the Commission and subject to review by the staff of the Division of Corporation Finance.

• Felony and misdemeanor convictions in connection with the purchase or sale of a security or involving the making of a false filing with the Commission (the same criminal conviction standard as in Section 926 of the Dodd-Frank Act) within the last five years in the case of issuers and ten years in the case of other covered persons;

• Injunctions and court orders within the last five years against engaging in or continuing conduct or practices in

connection with the purchase or sale of securities, or involving the making of any false filing with the Commission;

• U.S. Postal Service false representation orders within the last five years;

• Filing, or being named as an underwriter in, a registration statement or Regulation A offering statement that is the subject of a proceeding to determine whether a stop order should be issued, or as to which a stop order was issued within the last five years; and

• For covered persons other than the issuer:

○ being subject to a Commission order:

revoking or suspending their registration as a broker, dealer, municipal securities dealer, or investment adviser;

placing limitations on their activities as such;

barring them from association with any entity; or

barring them from participating in an offering of penny stock; or

○ being suspended or expelled from membership in, or suspended or barred from association with a member of, a registered national securities exchange or national securities association for conduct inconsistent with just and equitable principles of trade.

The disqualifying events specifically required by Section 926 are:

• Final orders issued by state securities, banking, credit union, and insurance regulators, federal banking regulators, and the National Credit Union Administration that either

○ bar a person from association with an entity regulated by the regulator issuing the order, or from engaging in the business of securities, insurance or banking, or from savings association or credit union activities; or

○ are based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within a ten-year period; and

• Felony and misdemeanor convictions in connection with the purchase or sale of a security or involving the making of a false filing with the Commission.

On May 25, 2011, we proposed amendments to Rules 501 and 506 of Regulation D and Form D to implement Section 926.

We received 44 comment letters in response to our proposal.

In addition, we received three advance comment letters commenting on Section 926 before the publication of the proposing release.

These comment letters and advance comment letters came from a variety of individuals, groups and constituencies, including state securities regulators, professional and trade associations, lawyers, academics and individual investors. Most commenters expressed general support for the proposed amendments and the objectives that we articulated in the proposing release, but many suggested modifications to the proposals.

See Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings,

Release No. 33-9211 (May 25, 2011) [76 FR 31518 (June 1, 2011)].

The comment letters we received on the proposal are available on our Web site at

http://www.sec.gov/comments/s7-21-11/s72111.shtml

. In this release, we refer to these letters as the “comment letters” to differentiate them from the “advance comment letters” described in note 26.

To facilitate public input on its Dodd-Frank Act rulemaking before issuance of rule proposals, the Commission provided a series of email links, organized by topic, on its Web site at

http://www.sec.gov/spotlight/regreformcomments.shtml

. In this release, we refer to comment letters we received on this rulemaking project in response to this invitation as “advance comment letters.” These advance comment letters appear on the Commission's Web site under the heading “Adding Disqualification Requirements to Regulation D Offerings, Title IX Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.”

Today we are adopting amendments to Rules 501 and 506 of Regulation D and to Form D to implement Section 926 of the Dodd-Frank Act.

The amendments we are adopting are generally consistent with the proposal, with the following principal differences:

We are also adopting technical amendments to Rules 145, 147, 152 and 155 to update references to Section 4(2) of the Securities Act, which was renumbered as Section 4(a)(2) by Section 201(c) of the JOBS Act, Public Law 112-106, sec. 201(c), 126 Stat. 306, 314 (Apr. 5, 2012).

• Disqualification will apply only for triggering events that occur after the effective date of the amendments; however, pre-existing matters will be subject to mandatory disclosure;

• The rule includes additional disqualifying events for certain orders of the Commodity Futures Trading Commission (“CFTC”) and for Commission cease-and-desist orders arising out of scienter-based anti-fraud violations and violations of Section 5 of the Securities Act;

• Instead of covering all officers of the issuer and of any compensated solicitors of purchasers of securities, the rule is limited to executive officers and officers who participate in the offering;

• Rather than covering beneficial owners of 10% or more of any class of the issuer's securities, the rule covers beneficial owners of 20% or more of the issuer's outstanding voting equity securities, calculated on the basis of voting power;

• For issuers that are pooled investment funds, the rule covers the funds' investment managers and their principals; and

• Disqualification will not apply if the authority issuing the relevant judgment, order or other triggering directive or statement determines and advises the Commission that disqualification from reliance on Rule 506 should not arise as a result.

Part III of the proposing release requested comment on a number of potential further rule amendments that would result in more uniform bad actor disqualification rules, including the application of the new bad actor disqualification standards to offerings under Regulation A, Regulation E and Rules 504 and 505 of Regulation D. Commenters were divided in their views with respect to uniform bad actor standards. Some commenters supported uniformity on the basis that it would enhance investor protection, increase clarity and consistency in our regulations and avoid the creation of opportunities for regulatory arbitrage.

Others opposed it, generally arguing that attempts to impose uniformity would be premature or inappropriate given the limits of the Dodd-Frank Act mandate, and that uniformity should be considered, if at all, in a separate rulemaking.

See

comment letters from the Federal Regulation of Securities Committee, Business Law Section of the American Bar Association (Oct. 4, 2011) (“ABA Fed. Reg. Comm.”); Chris Barnard (June 1, 2011) (“C. Barnard”); North American Securities Administrators Association, Inc. (July 25, 2011) (“NASAA”); SNR Denton LLC on behalf of The Depository Trust & Clearing Corporation (July 14, 2011) (“DTC”); Better Markets, Inc. (July 14, 2011) (“Better Markets”); Whitaker Chalk Swindle & Schwartz, PLLC (July 30, 2011 (“Whitaker Chalk”); and Professor J. Robert Brown, Jr. (Feb. 1, 2012).

See

comment letters from the Committee on Securities Regulation of the New York City Bar Association (July 14, 2011) (“NYCBA”); Cravath, Swaine & Moore LLP, Davis Polk & Wardwell LLP, Gibson, Dunn & Crutcher LLP, Skadden, Arps, Slate, Meagher & Flom LLP and Wilmer Cutler Pickering Hale and Dorr LLP (July 14, 2011) (“Five Firms”); SW. Coy Capital, Inc. (July 13, 2011) (“Coy Capital”).

We note that the JOBS Act requires us to adopt rules for two new exemptions from the Securities Act—one for “crowdfunding” offerings, contained in Title III of the JOBS Act, and one for offerings of up to $50 million in a 12-month period under Section 3(b) of the Securities Act, contained in Title IV of the JOBS Act. The statutory requirements for these exemptions contemplate bad actor disqualifications with language similar to that in Section 926 of the Dodd-Frank Act.

We are

working on separate rulemakings for these new exemptions. In light of these additional rulemakings, we have decided to limit the disqualification provisions adopted today to Rule 506 offerings. At the time of those rulemakings, we will have an opportunity to consider to what extent any bad actor disqualification provisions to be adopted in connection with those rules should differ from those applicable to Rule 506 offerings. At a later time, we will also have an opportunity to consider to what extent bad actor disqualifications currently applicable to Regulation A and Rule 505 offerings should be more uniform or similar to those applicable to Rule 506 offerings.

For crowdfunding, the Commission is directed to adopt rules establishing disqualification provisions for issuers, brokers and funding portals seeking to participate in crowdfunding transactions. The requirement in Section 302(d) of the JOBS Act

is identical to the language of Section 926 of the Dodd-Frank Act. For the new $50 million offering exemption, Section 401(b)(2) of the JOBS Act states that the Commission may require the issuer to meet certain conditions including disqualification provisions that are substantially similar to the disqualification provisions contained in regulations adopted in accordance with Section 926 of the Dodd-Frank Act, which we are adopting today.

II. Discussion of the Final Amendments

A. Introduction

Section 926(1) of the Dodd-Frank Act requires the Commission to adopt disqualification rules that are substantially similar to Rule 262, the bad actor disqualification provisions applicable to offerings under Regulation A, and that also cover the triggering events specified in Section 926. In general, we understand this mandate to mean that the provisions we adopt to implement Section 926 should have similar effects as Rule 262, except to the extent that circumstances, such as the different context for the use of Rule 506 compared to Regulation A and the need to update or otherwise revise the provisions of Regulation A, dictate a different approach.

B. Covered Persons

We proposed amendments to Rule 506 of Regulation D to apply the disqualification provisions required under Section 926 to the following categories of persons:

• The issuer and any predecessor of the issuer or affiliated issuer;

• Any director, officer,

general partner or managing member of the issuer;

Under Rule 405, the term “officer” is defined as “a president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any person routinely performing corresponding functions with respect to any organization.” 17 CFR 230.405. This definition is applicable to Rule 262 by virtue of Rule 261, 17 CFR 230.261.

• Any beneficial owner of 10% or more of any class of the issuer's equity securities;

• Any promoter connected with the issuer in any capacity at the time of the sale;

• Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering; and

• Any director, officer, general partner, or managing member of any such compensated solicitor.

See

Release No. 33-9211, Part II.B (May 25, 2011).

The proposal reflected the categories currently covered by Rule 262 of Regulation A, with two modifications. First, because Rule 506 transactions may involve the use of persons paid for solicitation of purchasers, such as placement agents and finders, rather than traditional underwriters, we added compensated solicitors as a category of covered persons.

In addition, we proposed to add managing members to the list of directors, officers and general partners of the issuer and any underwriter or compensated solicitor to standardize the treatment of controlling persons of limited liability companies for disqualification purposes.

This is modeled on the disqualification provisions for offerings under Rule 505 which, like Rule 506 offerings, may involve the use of placement agents and finders, rather than traditional underwriters.

See

17 CFR 230.505(b)(2)(iii)(B).

In the proposing release, we solicited comment on whether the rules should cover a broader or narrower group of persons. We specifically requested comment on whether the new disqualification provisions should cover all officers of issuers and covered financial intermediaries, as Rule 262 currently does, or only some officers (such as executive officers

and/or officers actually participating in the offering). We also requested comment on a variety of possible modifications to the scope of the coverage of shareholders and the possible inclusion of investment advisers of pooled investment funds.

The term “executive officer” is defined in Rule 501(f) of Regulation D (and in Rule 405) to mean a company's “president, any vice president . . . in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions.” 17 CFR 230.501(f), 230.405.

Officers.

Commenters generally supported limiting the coverage of the disqualification provisions to executive officers rather than all officers, citing such issues as the policy benefits of focusing on role rather than title;

the fact that executive officers of an issuer are recognized within Regulation D as “accredited investors” by virtue of their participation in the policy-making functions of the issuer;

the fact that certain entities have a large number of titular officers who do not have a policy or decision-making role or any involvement in the relevant offerings;

the potentially heavy compliance burden associated with broad application, which may make it difficult for issuers to meet a “reasonable care” standard;

and the obligation it would create for compensated solicitors to disclose the identities of their employees to issuers.

Some commenters argued for limiting the rule further as it applies to executive officers of compensated solicitors, and covering only executive officers that are engaged in the relevant private placement activities

or that are responsible for the approval or supervision of Rule 506 offerings.

See

comment letters from DTC; NYCBA; Sullivan & Cromwell LLP (July 14, 2011) (“S&C”).

See

comment letter from ABA Fed. Reg. Comm.

See

comment letters from ABA Fed. Reg. Comm.; S&C; Cleary Gottlieb Steen & Hamilton LLP (July 14, 2011) (“Cleary Gottlieb”); Lehman & Eilen LLP (July 14, 2011) (“Lehman & Eilen”).

See

comment letters from ABA Fed. Reg. Comm.; Cleary Gottlieb; Five Firms; S&C;

see

also

comment letter from Kutak Rock LLP (July 8, 2011) (“Kutak Rock”) (noting that a narrower rule would be more workable).

See

comment letter from Cleary Gottlieb.

See

comment letters from ABA Fed. Reg. Comm.; NYCBA.

See

comment letter from Lehman & Eilen.

Two commenters advocated that the new rules mirror Rule 262's coverage of “officers,” as proposed.

These commenters argued both that a rule “substantially similar” to Rule 262 must include officers and that, based on the presumption of control that attaches to officers, the ability of officers to set the tone of an organization and the risk that any officer may be involved with any given offering, coverage of “officers” is needed for the protection of investors.

See

comment letters from Better Markets; NASAA.

We also requested comment on whether the coverage of “officers” should be limited to officers who participate in or are involved with the offering. Two commenters addressed this point, acknowledging that it may be appropriate to cover participating officers to address investor protection concerns

and that doing so may be preferable to covering all officers.

Both commenters, however, expressed concern about the potential difficulty of determining which officers were

actually involved with or participating in an offering.

See

comment letter from Cleary Gottlieb.

See

comment letter from S&C.

See

comment letters from Cleary Gottlieb; S&C.

We agree with the majority of commenters that, in the context of Rule 506 offerings, an “officer” test based solely on job title would be unduly burdensome and overly restrictive. Consequently, the final rule covers only executive officers of covered entities and officers who participate in the offering. We believe that this coverage is an appropriate adaptation of the Rule 262 list of covered persons, taking into account the larger and more complex organizations that are involved in many Rule 506 transactions

as compared to the smaller entities that have used Regulation A, and, on that basis, this provision of the final rule is “substantially similar” to Rule 262. We note that the term “officer” in Rule 262 was used as early as 1955, before we adopted the “executive officer” concept that we use in several of our rules.

It also reflects a consideration of costs and benefits, focusing on situations where the risks that Section 926 is intended to address are at their most pronounced (when bad actors are performing policy-making functions or are personally involved with a securities offering) while alleviating the potential compliance burden by limiting covered persons to a more manageable number who should generally be easier to identify.

There is no cap on the amount of proceeds that may be raised in an offering relying on Rule 506, and many Rule 506 offerings are larger—in some cases, considerably larger—than would be permitted under the $5 million aggregate proceeds cap of Regulation A. For 2012, approximately 41% of Rule 506 offerings raised more than $5 million, 14% raised more than $50 million and 10% raised more than $100 million.

See Revision and Consolidation of Regulation A and Regulation D,

Release No. 33-3555 (July 18, 1955) [20 FR 5401 (July 28, 1955)].

Many issuers will already have determined who their executive officers are (among other reasons, to provide disclosure about executive officers in the offering materials), and the officers participating in an offering will be a question of fact. 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. We anticipate that issuers should be able to determine which of their own officers are participating in an offering without undue difficulty, and can exercise control over which officers participate. We also believe that it is reasonable to expect that compensated solicitors should be prepared to confirm which of their officers are participating in an offering as part of any engagement.

Beneficial Owners of Issuer Equity Securities.

The inclusion of holders of 10% or more of any class of the issuer's equity securities as covered persons was one of the areas of the proposing release that attracted the most comment. The majority of commenters did not support the inclusion of 10% beneficial owners as covered persons for purposes of the Rule 506 disqualification provisions.

Several commenters identified a range of potential burdens and costs issuers would face in identifying 10% beneficial owners. They described the inclusion of 10% beneficial owners in the context of Rule 506 offerings as unduly burdensome,

with 10% holders potentially a “moving target” for issuers engaged in continuous sales and regular redemptions.

Others pointed out that a person could acquire 10% or more of a class of securities while having no input or control over the company's management, or even having an adversarial relationship with management.

One commenter questioned whether public companies would be able to comply with the rule.

Two commenters urged the Commission not to include beneficial owners as covered persons at all in the new disqualification rule.

Some commenters suggested higher ownership thresholds, from 20% to majority ownership

or a test based on actual control,

while others argued against an actual control test and in favor of a bright-line standard based on a stated percentage of ownership.

See

comment letters from ABA Fed. Reg. Comm.; Cleary Gottlieb; Five Firms; Lehman & Eilen; NYCBA; S&C; Whitaker Chalk; the Investment Program Association (July 14, 2011) (“IPA”); Katten Muchin Rosenman LLP (July 14, 2011) (“Katten Muchin”); the Real Estate Investment Securities Association (July 14, 2011) (“REISA”); Seward & Kissel (July 20, 2011) (“Seward & Kissel”); the Securities Industry and Financial Markets Association (July 14, 2011) (“SIFMA”).

See

comment letter from Seward & Kissel.

See

comment letters from ABA Fed. Reg. Comm.; IPA.

See

comment letter from Lehman & Eilen;

see

also

comment letters from ABA Fed. Reg. Comm.; Five Firms; S&C.

See

comment letter from ABA Fed. Reg. Comm. (pointing out that 10% beneficial owners have no obligation to disclose whether they are bad actors).

See

comment letters from ABA Fed. Reg. Comm.; Seward & Kissel.

See

comment letters from ABA Fed. Reg. Comm. (25% ownership threshold, consistent with the “control” presumption in Section 2(a)(5) of the Investment Company Act); NYCBA (20% or 25%); IPA (20%); Lehman & Eilen (25%, consistent with the thresholds used in other contexts under the federal securities laws, including Form BD); Cleary Gottlieb (20%, consistent with the level at which reporting as a “passive” investor under Regulation 13D-G is no longer permitted); S&C (25%, consistent with the “control” presumptions in Form BD and Section 2(a)(9) of the Investment Company Act); Whitaker Chalk (at least 25%, and disregard if there is a controlling shareholder or group); SIFMA (at least 25%, which would accord with Form BD and Section 2(a)(9) of the Investment Company Act, but would prefer 50%); Seward & Kissel (if coverage of shareholders cannot be eliminated, increase threshold to a majority).

See

comment letters from Kutak Rock; REISA; Five Firms;

see also

comment letters from Whitaker Chalk (advocating use of the “affiliate” standard in Rule 144)

and

Seward & Kissel (remove 10% beneficial owners from the list of covered persons, or increase the ownership threshold to a majority interest).

See

comment letters from Cleary Gottlieb; NYCBA; S&C.

Some commenters also supported including only voting equity securities, rather than all equity securities, in determining which securityholders should be covered persons, generally arguing that only voting interests confer control.

More specifically, one commenter recommended that the disqualification provision incorporate the definition of “voting security” contained in Section 2(a)(42) of the Investment Company Act,

which includes only securities presently entitling the holder to vote for the election of directors, so that these rules would apply only to a beneficial owner of equity securities of an issuer who was entitled to vote for the election of directors (or their equivalents) of the issuer.

Another suggested that the provision be limited to voting securities, including general partner and managing member interests, and exclude passive interests.

See

comment letters from ABA Fed. Reg. Comm.; Kutak Rock; Lehman & Eilen; NYCBA; Whitaker Chalk;

see

also

Seward & Kissel (objecting to the disqualification of pooled investment funds based on the conduct of a 10% passive equity owner).Comment letter from NYCBA.

15 U.S.C. 80a-2(a)(42).

See

comment letter from ABA Fed. Reg. Comm.

See

comment letter from NYCBA.

Other commenters supported the proposed inclusion of 10% beneficial owners of any class of the issuer's equity securities, based on their presumptive control of the issuer and the mandate to adopt rules that are “substantially similar” to Rule 262, which covers 10% beneficial owners.

See

comment letters from Better Markets; DTC; NASAA; Bybel Rutledge LLP (July 11, 2011) (“Rutledge”).

We are persuaded, with the majority of commenters, that the Rule 262 standard of 10% ownership of any class of the issuer's equity securities could be overinclusive, pulling in securityholders who do not control the activities of the issuer and whose prior bad conduct may not reflect on the issuer or the current offering. It may

therefore impose costs and burdens that are not justified in relation to the potential benefits. We considered in particular the underlying objectives of the bad actor rules, as well as the potential administrative complexity of monitoring fluctuating ownership levels resulting from continuous sales or regular redemptions by certain issuers, and an issuer's inability to control the actions of an adversarial or non-compliant securityholder who does not disclose whether its relationship to the issuer may trigger disqualification.

We agree with most commenters that it would be appropriate to limit the coverage of securityholders under new Rule 506(d) to those having voting rights. In light of the range of possible structures and control arrangements among issuers relying on Rule 506, however, we have not adopted a specific definition of “voting securities.” We intend that the term should be applied based on whether securityholders have or share the ability, either currently or on a contingent basis, to control or significantly influence the management and policies of the issuer through the exercise of a voting right.

For example, we would consider that securities that confer to securityholders the right to elect or remove the directors or equivalent controlling persons of the issuer, or to approve significant transactions such as acquisitions, dispositions or financings, would be considered voting securities for purposes of the rule. Conversely, securities that confer voting rights limited solely to approval of changes to the rights and preferences of the class would not be considered voting securities for purposes of the rule.

We note that securityholders that have the ability to control or significantly influence the management and policies of the issuer through other means will generally be covered by Rule 506(d) in another capacity, such as, for example, as the functional equivalent of an “executive officer” or “director” of an issuer.

We are also concerned that measuring ownership based on the percentage beneficial ownership of any class of an issuer's securities, rather than of the issuer's total outstanding securities, may be both overinclusive and underinclusive. Where a class of securities represents a very small percentage of the issuer's outstanding equity securities or voting power, even a large percentage ownership of the class may not confer the kind of control or influence over the issuer that the bad actor disqualification rules are intended to address. At the same time, in the case of a class of supervoting or high vote securities, ownership of a relatively small percentage of that class may carry with it control over a relatively large percentage of total voting power. Accordingly, rather than including beneficial owners of any class of the issuer's equity securities, the final rule includes beneficial owners of a specified percentage of the issuer's total outstanding voting equity securities, calculated on the basis of voting power. This change will focus the rule on securityholders that have or share the ability to direct a substantial portion of a vote, and will avoid the potential overinclusiveness and underinclusiveness of a share-based or class-based calculation.

After considering commenters' concerns, we have also determined to raise the beneficial ownership threshold from 10% to 20%, which we believe is a reasonable and measured approach in the context of Rule 506 offerings that preserves investor protection and provides an efficient and clear “bright-line” test.

We note that the 20% threshold aligns with the level of ownership at which filing as a “passive investor” on Schedule 13G under Regulation 13D-G is no longer permitted.

See

17 CFR 230.13d-1(c).

Accordingly, the rules we adopt today cover beneficial owners of 20% or more of the issuer's outstanding equity securities, calculated on the basis of voting power, rather than 10% beneficial owners of any class of securities, as originally proposed.

We considered, but are not adopting, a standard based on actual control of the issuer. We share the concern voiced by some commenters

that a facts-and-circumstances based standard such as actual control would significantly increase the burden of inquiry associated with determining whether an offering was disqualified, and may give rise to unnecessary cost and uncertainty in the application of Rule 506(d). We believe that keeping a “bright-line” standard based on a specified level of ownership reduces the burden of compliance and responds to the statutory mandate to adopt a rule that is “substantially similar” to Rule 262.

See

comment letters from Cleary Gottlieb; NYCBA; S&C.

Assessing beneficial share ownership based on ownership of total outstanding voting securities, based on voting power, rather than ownership of any class, and increasing the ownership threshold from 10% to 20% should ease the burden of compliance because there will be fewer beneficial owners to track. Nevertheless, we do not believe that the change will diminish the investor protection benefits of Rule 506(d) in the circumstances posing the highest potential risk to investors, when securityholders exercise actual control over the issuer, because such securityholders are likely to be covered persons in some other capacity. Under the functional definitions of “director” and “executive officer,” anyone who performs the functions of a director; controls a principal business unit, division or function of the issuer or performs policy making functions for the issuer will be a covered person as a director or executive officer of the issuer. In addition, as discussed below, shareholders that are “promoters” involved with the issuer will be covered in that capacity.

Investment Managers of Pooled Investment Funds.

After further consideration and review of comment letters, we have determined to expand the list of covered persons to include investment managers

of issuers that are pooled investment funds; the directors, executive officers, other officers participating in the offering, general partners and managing members of such investment managers; and the directors and executive officers of such general partners and managing members and their other officers participating in the offering.

We requested comment on whether to include investment advisers of private funds, but did not propose to include them. Three commenters supported such an expansion to promote investor protection,

while six opposed it on a variety of bases, including that investment advisers are already subject to fiduciary duties and an extensive regulatory regime;

that persons who actually control a pooled investment fund issuer would likely be covered in other capacities, for example as promoters or through a position with

the fund's general partner;

and that extending the rule in this way would be premature, would require a separate rulemaking project or would violate the “substantially similar” requirement.

We agree that, depending on the circumstances, investment managers that actually control a pooled investment fund may already be covered persons as “promoters” (a concept discussed in greater detail below), or as “directors” or “executive officers” of the issuer. We also note that the regulation of investment advisers has been subject to recent change, so that many investment managers to pooled investment funds that invest in securities are subject to new reporting and other obligations.

As a result of our reconsideration and review of the comment letters, however, we have determined to include investment managers to pooled investment funds and their principals as covered persons in the Rule 506 disqualification rules.

We are using the term “investment manager,” rather than “investment adviser” as discussed in the proposing release. Under Section 202(a)(11) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-2(a)(11)] “(the “Advisers Act”)”, an “investment adviser” is generally a person or firm that, for compensation, is engaged in the business of providing advice, making recommendations, issuing reports, or furnishing analyses on securities. Some pooled investment funds invest in assets other than securities, such as commodities, real estate and certain derivatives. In order to ensure that Rule 506(d) covers the control persons of these funds, we are using a more general term, which encompasses both investment advisers and other investment managers.

We are not adopting a definition of the term “pooled investment fund” as it is used in Rule 506(d). The term has been used in Form D for years in its ordinary and commonly understood sense, and we intend to use it in Rule 506(d) in the same way. The term should not be confused with “pooled investment vehicle,” a term defined more narrowly in Rule 206(4)-8 under the Advisers Act, 17 CFR 275.206(4)-8.

See

comment letters from Better Markets; DTC; NASAA.

See

comment letters from ABA Fed. Reg. Comm.; SIFMA; Whitaker Chalk.

See

comment letter from Katten Muchin;

See

comment letters from Lehman & Eilen; Rutledge.

See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF,

Release No. IA-3308 (Oct 31, 2011) [76 FR 71128];

Rules Implementing Amendments to the Investment Advisers Act of 1940,

Release No. IA-3221 (June 22, 2011) [76 FR 42950].

See

Rule 506(d)(1).

Most operating companies making Rule 506 offerings are corporations or limited liability companies that function through their officers, directors and managing members. By comparison, most pooled investment funds making Rule 506 offerings are partnerships or other flow-through entities that have few, if any, employees, and function through their investment managers and the managers' personnel. In order to provide equivalent treatment of operating companies and pooled investment funds, the final rule establishes a new “bright-line” category of presumed control persons for pooled investment fund issuers. This should make the final rule clearer and easier to apply, and will more effectively protect investors from bad actors that exercise influence or control over a pooled investment fund.

Some commenters argued that adding fund investment managers was unnecessary, given that fund investment advisers are generally subject to regulation either at the state or the federal level. We believe our Securities Act disqualification rules are, in many respects, designed to supplement and build upon other enforcement and regulatory efforts. For instance, registered broker-dealers subject to limitations on their activities as a result of disciplinary proceedings could separately be disqualified from participating in a Rule 506 offering under the amendments we adopt today. We do not believe that the regulatory scheme to which a pooled investment fund's investment manager may be subject is a substitute for bad actor disqualification.

We appreciate that the bad actor provisions in Rule 262 do not cover investment managers of issuers that are pooled investment funds. Regulation A, however, is generally not available to or used by pooled investment funds,

so its disqualification provisions do not have to address the structure and governance arrangements typical of pooled investment fund issuers. Analogous disqualification rules under the Securities Act and the Investment Company Act do, however, include investment managers of pooled investment funds. For example, the disqualification provisions of Regulation E (which, like Regulation A, is an exemption from registration under Section 3(b)(1) of the Securities Act,

but is designed for use by pooled investment funds and similar entities) include as covered persons both the investment adviser to a pooled investment fund issuer as well as partners, directors, and officers of the investment adviser.

Similarly, Section 9(a) of the Investment Company Act automatically disqualifies investment advisers of registered investment companies (and certain affiliated persons) based on criminal convictions and certain court orders.

Regulation A by its terms is not available to any pooled investment fund that is an “investment company registered or required to be registered under the Investment Company Act of 1940.” 17 CFR 230.251(a)(4). As a practical matter, it is not available to other pooled investment funds because most such funds attempt to maintain that status under either Section 3(c)(1) or Section 3(c)(7) of that statute, which prohibits them from engaging in public offerings like those under Regulation A.

See

Investment Company Act secs. 3(c)(1), 3(c)(7), 15 U.S.C. 80a-3(c)(1), 80a-3(c)(7).

15 U.S.C. 77c(b)(1).

17 CFR 230.602(c).

See

15 U.S.C. 80a-9(a).

We also recognize that, depending on the circumstances, some investment managers of pooled investment funds and certain of their personnel would be covered already under Rule 506(d), even if we did not expand the coverage of the rule. For example, some investment manager firms would be deemed to be “promoters” of a pooled investment fund issuer, and some of their individual principals would be deemed the functional equivalent of “directors,” “executive officers” or “promoters” of the issuer. Nevertheless, since we have concluded that such persons should be covered, we believe it is preferable to cover them directly, rather than indirectly. This treatment will avoid the necessity for issuers or others to engage in a potentially time-consuming, fact-intensive inquiry to determine whether or not they are within another category of covered persons.

Promoters.

Although “promoters” are included as covered persons in Rule 262

and were included as covered persons in the proposed rules for that reason, three commenters raised questions about the treatment of promoters under the new disqualification rules.

One suggested that directors, executive officers, general partners and managing members of promoters be included, so that promoters would be addressed in the rule in the same way as issuers and compensated solicitors.

The second questioned whether inclusion was necessary given the breadth of the other categories of covered persons, but suggested that if promoters are included, the term should be defined so as to include only persons who are involved with the offering and have a material financial interest in its outcome (or at a minimum, the rule should be revised to make clear that fund investment advisers are not deemed to be promoters).

The third argued that promoters should not be covered persons unless they are involved in the day-to-day management of the issuer or will be paid remuneration for the solicitation of purchasers.

Rule 262(b) covers “any promoter of the issuer presently connected with it in any capacity.” The term “promoter” is defined in Rule 405 to mean any person who: (i) Acting alone or together with others, directly or indirectly takes initiative in founding or organizing the business or enterprise of an issuer; or (ii) in connection with the founding or organization of the business or enterprise of an issuer, directly or indirectly receives 10% or more of any class of issuer securities or 10% or more of the proceeds from the sale of any class of issuer securities (not including securities received solely as underwriting commissions or solely in exchange for property). The Rule 405 definition applies to Rule 262 by virtue of Rule 261. 17 CFR 230.261.

See

comment letters from Cleary Gottlieb; SIFMA; S&C.

See

comment letter from Cleary Gottlieb.

See

comment letter from S&C.

See

comment letter from SIFMA.

We determined not to make any changes in the definition or coverage of promoters. The category of “promoter” is broad, and captures all individuals and entities that have the relationships with the issuer or to the offering specified in Rule 405.

In particular, the definition requires issuers to look through entities and makes it

unnecessary for us to separately cover the officers, directors and other control persons of entities that qualify as promoters. Rule 405 defines a promoter as any person—individual or legal entity—that either alone or with others, directly or indirectly takes initiative in founding the business or enterprise of the issuer, or, in connection with such founding or organization, directly or indirectly receives 10% or more of any class of issuer securities or 10% or more of the proceeds from the sale of any class of issuer securities (other than securities received solely as underwriting commissions or solely in exchange for property). The test considers activities “alone or together with others, directly or indirectly”; therefore, the result does not change if there are other legal entities (which may themselves be promoters) in the chain between that person and the issuer.

See

note 77.

As adopted, the disqualification provisions of Rule 506(d) will cover the following persons, which we refer to in this release as “covered persons”:

• The issuer and any predecessor of the issuer or affiliated issuer;

• Any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer;

• Any beneficial owner of 20% or more of the issuer's outstanding voting equity securities, calculated on the basis of voting power;

• Any investment manager to an issuer that is a pooled investment fund and any director, executive officer, other officer participating in the offering, general partner or managing member of any such investment manager, as well as any director, executive officer or officer participating in the offering of any such general partner or managing member;

• Any promoter connected with the issuer in any capacity at the time of the sale;

• Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering (which we refer to as a “compensated solicitor”); and

• Any director, executive officer, other officer participating in the offering, general partner, or managing member of any such compensated solicitor.

See

Rule 506(d)(1).

We are also adopting a provision under which events relating to certain affiliated issuers are not disqualifying if they pre-date the affiliate relationship.

Rule 262(a)(5) currently provides that orders, judgments and decrees entered against affiliated issuers before the affiliation arose do not disqualify an offering if the affiliated issuer is not (i) in control of the issuer or (ii) under common control, together with the issuer, by a third party that controlled the affiliated issuer at the time such order, judgment or decree was entered. We included a similar provision in the proposal, but clarified that it applied to all potentially disqualifying events that pre-date affiliation. All of the commenters that addressed that point were supportive of the proposal,

and we are adopting it as proposed.

See

Rule 506(d)(3).

See

comment letters from ABA Fed. Reg. Comm.; NYCBA; Rutledge; Whitaker Chalk; Alfaro Oil and Gas LLC (July 14, 2011) (“Alfaro”).

We also solicited comment on whether we should apply the disqualification rules differently to entities that have undergone a change of control. Five commenters supported differential treatment following a change of control, primarily arguing that entities act only through their personnel, and disqualifying events would no longer be relevant if the persons responsible for the events are no longer in control.

Another commenter argued that disqualification should cease to apply following changes of policy, as well as changes of control.

Three commenters opposed providing different treatment for entities that have undergone a change of control, generally noting that it would be difficult to establish whether a change of control had occurred, that such a provision could be susceptible to abuse, and that change of control might more appropriately be considered in the context of an application for waiver of disqualification.

We have decided to adopt the rules as proposed, as advocated by the latter group of commenters, and are not providing different treatment for entities that have undergone a change of control or a change of policy. We wish to avoid both undue complexity in application of the rules and potential abuse by bad actors that may claim to have undergone a change of control when no bona fide change of control has in fact occurred. As discussed in Part II.E below, we are amending the existing delegation of authority to the Director of the Division of Corporation Finance so it will cover waivers of disqualification under Rule 506. We expect that staff will adopt procedures for the prompt issuance of waivers of Rule 506 disqualification upon a proper showing that there has been a change of control and the persons responsible for the activities resulting in a disqualification are no longer employed by the entity or exercise influence over such entity.

See

comment letters from ABA Fed. Reg. Comm.; Five Firms; Kutak Rock; Lehman & Eilen, Whitaker Chalk;

see

also

comment letter from L. Burningham (June 29, 2011) (“Burningham”) (suggesting that issuers not be disqualified if they have removed bad actors).

See

comment letter from SIFMA (disqualification should apply only if senior management in control when disqualifying event arose are still employed by the issuer or a controlling affiliate continues in a senior management or executive role; disqualification should also cease to apply if issuer has implemented policies and procedures designed to prevent occurrence of activities that gave rise to disqualification, and such policies and procedures have been approved by a regulator or a court).

See

comment letters from DTC; NYCBA; Rutledge.

C. Disqualifying Events

Section 926 of the Dodd-Frank Act requires our Rule 506 disqualification provisions to be “substantially similar” to those set forth in Rule 262 of Regulation A, and also to cover certain criminal convictions and regulatory orders enumerated in Section 926. In the proposal, the disqualifying events from Rule 262 and Section 926 were combined and integrated in a proposed rule that included the following disqualifying events:

• Criminal convictions (felony or misdemeanor), entered within the last five years in the case of issuers and ten years in the case of other covered persons, in connection with the purchase or sale of any security; involving the making of a false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities;

See

Proposed Rule 506(c)(1)(i).

• Court injunctions and restraining orders, including any order, judgment or decree of any court of competent jurisdiction, entered within five years before such sale, that, at the time of such sale, restrains or enjoins such person from engaging or continuing to engage in any conduct or practice in connection with the purchase or sale of any security; involving the making of a false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities;

See

Proposed Rule 506(c)(1)(ii).

• Final orders issued by state banking, credit union, and insurance regulators, federal banking regulators, and the National Credit Union Administration that either create a bar from association with any entity regulated by the regulator issuing the

order, or from engaging in the business of securities, insurance or banking or from savings association or credit union activities; or are based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within the last ten years;

See

Proposed Rule 506(c)(1)(iii).

• Commission disciplinary orders entered pursuant to Section 15(b) or 15(B)(c) of the Securities Exchange Act of 1934 (the “Exchange Act”) or Section 203(e) or (f) of the Investment Advisers Act of 1940 (the “Advisers Act”) that, at time of the sale, suspend or revoke a person's registration as a broker, dealer, municipal securities dealer or investment adviser; place limitations on the activities, functions or operations of such person; or bar such person from being associated with any entity or from participating in the offering of any penny stock;

See

Proposed Rule 506(c)(1)(iv).

• Suspension or expulsion from membership in, or suspension or a bar from association with a member of, an SRO,

i.e.,

a registered national securities exchange or a registered national or affiliated securities association;

See

Proposed Rule 506(c)(1)(v).

• Stop orders applicable to a registration statement and orders suspending the Regulation A exemption for an offering statement that an issuer filed or in which the person was named as an underwriter within the last five years and being the subject at the time of sale of a proceeding to determine whether such a stop or suspension order should be issued;

and

See

Proposed Rule 506(c)(1)(vi).

• U.S. Postal Service false representation orders including temporary or preliminary orders entered within the last five years.

See

Proposed Rule 506(c)(1)(vii).

We solicited comment on a number of possible modifications to the list of disqualifying events, such as including additional events and lengthening or shortening the look-back period associated with each event. Following is a discussion of each of the disqualifying events originally proposed, the comments on the proposal and the disqualifying event as adopted today.

1. Criminal Convictions

Section 926(2)(B) of the Dodd-Frank Act provides for disqualification if any covered person “has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the Commission.” This essentially mirrors the language of Rule 262(a)(3), which covers criminal convictions of issuers, and Rule 262(b)(1), which covers criminal convictions of other covered persons. In the proposing release, we identified two differences between the felony and misdemeanor conviction provisions of Section 926(2)(B) and Rule 262. First, Section 926(2)(B) does not include a specific time limit (or “look-back period”) on convictions that trigger disqualification, whereas Rule 262 provides a five-year look-back period for criminal convictions of issuers and a ten-year look-back period for criminal convictions of other covered persons. Second, Rule 262 includes a reference to criminal convictions “arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer or investment adviser,” which does not appear in Section 926.

The proposed rule was based on Rule 262, and provided that a covered person would be disqualified if such covered person has been convicted, within ten years before such sale (or five years, in the case of issuers, their predecessors and affiliated issuers), of any felony or misdemeanor in connection with the purchase or sale of any security; involving the making of any false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.

Proposed Rule 506(c)(1)(i).

The proposed rule included look-back periods of five years for criminal convictions of issuers (including predecessors and affiliated issuers) and ten years for other covered persons, which correspond to Rule 262.

We requested comment on whether the scope of the provision should be broader or narrower, and whether a longer, or permanent, look-back period would be appropriate for either issuers or other covered persons.

Consistent with Rule 262, the look-back period is to the date of the conviction, not to the date of the conduct that led to the conviction. The measurement date is the date of the relevant order or other sanction, not the date of the conduct that was the subject of the order or other sanction.

Commenters were divided in their reaction to this aspect of the proposal. Most commenters argued that the Commission should stay close to the language of Section 926 and Rule 262.

One commenter criticized the proposal as overbroad and suggested ways to narrow it,

while two commenters urged expansion of the rule to cover a broader range of criminal convictions.

100

In an advance comment letter

101

and again in its comment letter, NASAA argued for extension of the disqualification rules to cover all criminal convictions involving fraud or deceit, as well as convictions involving the making of a false filing with any state, involving a commodity future or option contract, or any aspect of a business involving securities, commodities, investments, franchises, insurance, banking or finance. One other commenter supported extending coverage to all criminal convictions involving fraud or deceit.

102

Three commenters expressly opposed NASAA's suggested extension on the basis that it would create a vague and overbroad standard.

103

See

comment letters from Rutledge; Five Firms; S&C; Seward & Kissel; SIFMA; NYCBA.

See

comment letter from REISA (suggesting limiting false filings provision to “intentional, material and misleading” false filings and limiting convictions “arising out of the business” to those “directly related to the offer or sale of securities to investors”).

100

See

comment letters from NASAA; Better Markets.

101

See

advance comment letter from NASAA (Nov. 4, 2010).

102

See

comment letter from Better Markets.

103

See

comment letters from NYCBA; S&C; SIFMA.

On the length of look-back periods, some commenters argued for a uniform ten-year period,

104

some for longer or permanent disqualification in certain cases,

105

some for the five- and ten-year periods proposed,

106

and some for shorter periods for covered persons and issuers.

107

On whether convictions in foreign courts should be considered, most commenters objected, generally citing due process concerns and concerns about the cost and burden of inquiry into foreign proceedings.

108

Four commenters supported adding foreign convictions, generally on the basis that conduct outside the United States was as relevant as conduct within the United States for disqualification purposes.

109

One commenter suggested

that Section 926(2)(B) could be read not to be limited to U.S. proceedings.

110

104

See

comment letters from Better Markets; Kutak Rock;

see

also

comment letters from NASAA (uniform look-back period of at least ten years); DTC (ten-year look-back except permanent disqualification for securities fraud and violations of Rule 506).

105

See

comment letters from DTC (permanent disqualification for securities fraud and Section 5 violations); J. Davis (June 13, 2011) (suggesting that conviction of any securities violation or felony should be permanently disqualifying).

106

See

comment letters from Cleary Gottlieb; Rutledge.

107

See

comment letters from REISA (uniform five-year period); D. Sarna (August 23, 2011) (uniform five-year period); SIFMA (uniform period not longer than one year).

108

See

comment letters from Cleary Gottlieb; Five Firms; NYCBA; S&C; Sullivan & Worcester LLP (July 1, 2011) (“S&W”); SIFMA; Whitaker Chalk.

109

See

comment letters from C. Barnard; DTC; Better Markets; advance comment letter from NASAA.

110

See

comment letter from Rutledge.

In sum, most commenters agreed that the final rules should be closely based on Rule 262. To the extent that commenters advocated changes from the proposal, however, there was no consensus about what changes would be desirable or appropriate. We do not believe that the shift from Regulation A to potentially larger and more complex transactions under Rule 506 warrants either expanding or narrowing the scope of coverage of criminal convictions, or modifying the existing five- and ten-year look-back periods. Given that the rule is required to be “substantially similar” to Rule 262, and that there are no changes warranted by the application to the Rule 506 context, we are adopting the provision as proposed.

2. Court Injunctions and Restraining Orders

Under current Rule 262(a)(4), an issuer is disqualified from reliance on Regulation A if it, or any predecessor or affiliated issuer, is subject to a court injunction or restraining order against “engaging in or continuing any conduct or practice in connection with the purchase or sale of any security or involving the making of any false filing with the Commission.”

111

Similarly, under current Rule 262(b)(2), an offering is disqualified if any other covered person is subject to such a court injunction or restraining order, or to one “arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer or investment adviser.”

112

Disqualification is triggered by temporary or preliminary injunctions and restraining orders that are currently in effect, and by permanent injunctions and restraining orders entered within the last five years.

113

111

17 CFR 230.262(a)(4).

112

17 CFR 230.262(b)(2).

113

Disqualification is triggered only when a person “is subject to” a relevant injunction or order. Therefore, injunctions and orders that have expired or are otherwise no longer in effect are not disqualifying, even if they were issued within the relevant look-back period. For example, an injunction issued four years before the relevant securities offering (within the five-year look-back period), and then lifted before the offering occurred, would not be disqualifying. The look-back period functions as a cut-off for injunctions and orders that are still in effect at the time of an offering. For example, disqualification will not arise from an injunction issued more than five years before an offering, even if the injunction is permanent.

The proposed provision reflected the substance of these two provisions in a simplified, combined format. Rule 506 transactions may involve compensated solicitors, rather than traditional underwriters, so the proposed rule also covered orders arising out of the conduct of the business of such compensated solicitors. Under the proposal, an offering would be disqualified if any covered person is subject to any order, judgment or decree of any court of competent jurisdiction, entered within five years before any sale in the offering that, at the time of such sale, restrains or enjoins such person from engaging or continuing to engage in any conduct or practice in connection with the purchase or sale of any security; involving the making of any false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.

114

Proposed Rule 506(c)(1)(ii).

Five commenters recommended adoption of the provisions as proposed.

115

Two commenters suggested narrowing the coverage of orders arising out of the conduct of the business of the listed financial intermediaries, and limiting the provision either to cases where there is a finding of fraudulent, manipulative or deceptive conduct,

116

or to matters relating to a broker-dealer's activities of offering securities as a placement or selling agent or underwriter.

117

Two commenters argued that court orders and judgments should not trigger disqualification unless the defendant was afforded notice and an opportunity to appear.

118

One such commenter went further to recommend that all appeals should have been exhausted or the time for appeal expired before disqualification is triggered.

119

115

See

comment letters from Cleary Gottlieb; Lehman & Eilen; NYCBA; Rutledge (arguing, as to look-back periods in particular, that “substantially similar” means that new rules should mirror as much as possible existing Rule 262 provisions); SIFMA.

116

See

comment letter from NYCBA (acknowledging that the limitation they recommend may not be “substantially similar” to Rule 262).

117

See

comment letter from SIFMA.

118

See

comment letters from ABA Fed. Reg. Comm.; R. Sherman (May 25, 2011).

119

See

comment letter from ABA Fed. Reg. Comm.

One commenter requested clarification that disqualification will apply only for persons specifically named in an order, and not to all who may be within a class of persons brought within the scope of an order.

120

For example, an injunction may be issued against a named defendant “and its agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice” of the order. The commenter requested confirmation that, in these circumstances, only the named defendant, and not all members of the class of persons brought within the scope of the order, would be understood as “subject to” the order for disqualification purposes.

120

See

comment letter from ABA Fed. Reg. Comm.

We are adopting the provision as proposed. We see no basis for departing from the coverage and look-back periods that apply under existing Rule 262. In particular, we have determined not to impose due process requirements, such as notice and an opportunity to appear, or to require that all appeals have been exhausted or the time for appeal expired, as a condition to disqualification. We are sensitive to the concerns raised by commenters about the risk that ex parte orders may trigger disqualification. Nevertheless, in light of the statutory mandate and the Commission's waiver authority, we are not narrowing the provision. We believe that disqualifying events that arise out of such circumstances are better addressed through the waiver process.

We are also not persuaded that the shift to potentially larger, more complex transactions under Rule 506 or other considerations justifies such a change from the Rule 262 standards. Nor do we want to add a significant new burden of inquiry, requiring issuers to determine not just that a covered person is subject to an order, but also that the order is procedurally adequate. On balance, we believe that the risk that disqualification may arise from ex parte proceedings could be better addressed through the waiver process, rather than through additional requirements for factual inquiry that would affect all offerings. As for appealable orders, as noted in the proposing release, we are concerned that suspending disqualification during the pendency of a potentially lengthy appeals process may significantly undermine the intended benefits of the rule.

121

Disqualification would be terminated immediately, however, if the judgment or order were reversed or vacated.

With regard to who would be viewed as subject to an order, we intend to apply the new provisions consistently with the way that Rule 262 has historically been applied. For disqualification purposes, the staff has interpreted Rule 262 to limit those considered “subject to” an order to only the persons specifically named in the order.

122

Others who are not specifically

named but who come within the scope of an order (such as, for example, agents, attorneys and persons acting in concert with the named person) will not be treated as “subject to” the order for purposes of disqualification.

122

For a more general discussion of interpretations of the meaning of “subject to” an order,

see

note 156 and accompanying text.

3. Final Orders of Certain Regulators

The text of Section 926(2)(A) of the Dodd-Frank Act provides that Commission requirements for Rule 506 offerings must disqualify any covered person that

(A) is subject to a final order of a State securities commission (or an agency or officer of a State performing like functions), a State authority that supervises or examines banks, savings associations, or credit unions, a State insurance commission (or an agency or officer of a State performing like functions), an appropriate Federal banking agency, or the National Credit Union Administration, that—

(i) bars the person from—

(I) association with an entity regulated by such commission, authority, agency, or officer;

(II) engaging in the business of securities, insurance, or banking; or

(III) engaging in savings association or credit union activities; or

(ii) constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within the 10-year period ending on the date of filing of the offer or sale.

As we noted in the proposing release, Section 926(2)(A) is essentially identical to Section 15(b)(4)(H) of the Exchange Act and Section 203(e)(9) of the Advisers Act. The only difference is that Section 926(2)(A)(ii) contains a ten-year look-back period for final orders based on violations of laws and regulations that prohibit fraudulent, manipulative and deceptive conduct, while the Exchange Act and Advisers Act provisions have no express time limit for such orders.

We proposed to reflect Section 926(2)(A) as new Rule 506(c)(1)(iii), with three changes from the text of Section 926(2)(A), which were intended to eliminate potential ambiguities and allow for easier application of the rule. First, the proposal specified that an order must bar the covered person “at the time of [the] sale,” to clarify that a bar would be disqualifying only for as long as it has continuing effect. Second, the provision measured the look-back period from the date of the relevant sale, not from “the date of filing of the offer or sale,” as provided in Section 926 of the Dodd-Frank Act, so it would align with the other look-back periods in the rule. Finally, the provision required that orders must have been “entered” within the look-back period, to clarify that the date of the order, and not the date of the underlying conduct, was relevant for that determination.

Under the proposal, an offering would be disqualified if any covered person is subject to a final order of a state securities commission (or an agency or officer of a state performing like functions); a state authority that supervises or examines banks, savings associations, or credit unions; a state insurance commission (or an agency or officer of a state performing like functions); an appropriate federal banking agency; or the National Credit Union Administration that at the time of such sale, bars the person from association with an entity regulated by such commission, authority, agency, or officer; engaging in the business of securities, insurance or banking; or engaging in savings association or credit union activities; or constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before such sale.

123

Proposed Rule 506(c)(1)(iii).

We solicited comment on a number of aspects of the proposed provision, including the treatment of bars, the definition of the terms “final order” and “fraudulent, manipulative and deceptive conduct,” and the potential to cover orders of other regulators in addition to those mandated by Section 926 of the Dodd-Frank Act, particularly the Commission and the Commodity Futures Trading Commission (“CFTC”). As discussed in more detail below, we are adopting the provision substantially as proposed, but adding the CFTC to the list of regulators whose regulatory bars and other final orders will trigger disqualification.

CFTC Orders.

The proposing release solicited comment on whether orders of the CFTC or any other regulator not referred to in Section 926 should result in disqualification from Rule 506 offerings. Four commenters favored adding CFTC orders as a disqualification trigger.

124

One noted that “conduct that would typically give rise to a CFTC sanction is similar to the type of conduct that would result in disqualification if it were the subject of action by other regulators in the securities, banking and insurance fields.”

125

Others cited benefits such as improved investor protection, harmonization of the treatment of regulatory entities, and improved internal consistency of the bad actor rules.

126

Another asserted that it was “obvious” that at least some CFTC orders should be covered by the disqualification rules.

127

Two of these commenters also recommended that the rules cover orders of additional regulators.

128

Seven comment letters opposed adding CFTC orders, generally arguing that such an addition would not be “substantially similar” to Rule 262 and questioning the Commission's legal authority to add such a new disqualifying event.

129

124

See

comment letters from Better Markets, Cleary Gottlieb, NYCBA, NASAA.

125

See

comment letter from Better Markets.

126

See

comment letters from Cleary Gottlieb, NASAA.

127

See

comment letter from NYCBA.

128

See

comment letters from Better Markets (advocating addition of orders by other agencies with jurisdiction over misconduct in the financial services arena, including the Consumer Financial Protection Bureau and the Federal Trade Commission); NASAA (advocating addition of orders under state franchise, investment and finance laws).

129

See

comment letters from ABA Fed. Reg. Comm.; Five Firms; Katten Muchin; Lehman & Eilen; Rutledge; Schuyler Roche; SIFMA.

We are persuaded that appropriate CFTC orders should be included as a disqualification trigger in new Rule 506(d). As we noted in the proposing release, the conduct that would typically give rise to CFTC sanctions is similar to the type of conduct that would result in disqualification if it were the subject of sanctions by another financial services industry regulator. For that reason, CFTC orders trigger consequences under other Commission rules (for example, both registered broker-dealers and investment advisers may be subject to Commission disciplinary action based on violations of the Commodity Exchange Act).

130

In addition, the CFTC (rather than the Commission) has authority over the investment managers of pooled investment funds that invest in commodities and certain derivatives products; unless Rule 506(d) covers CFTC orders, regulatory sanctions against those investment managers are not likely to trigger disqualification. For these reasons, we believe that including orders of the CFTC will make the bad actor rules more internally consistent, treating relevant sanctions similarly for disqualification purposes, and should enable the disqualification rules to more effectively screen out felons and bad actors.

130

See, e.g.,

Section 15(b)(4)(D) of the Exchange Act (15 U.S.C. 80(b)(4)(C)) and Section 203(e)(5) of the Advisers Act (15 U.S.C. 80-b3(e)(5)).

We have decided to include CFTC orders in the bad actor disqualification scheme by adding the CFTC to the list of regulators in Rule 506(d)(1)(iii). As a result, disqualification will be triggered

only by CFTC orders that constitute “bars” or “final orders” relating to prohibitions on “fraudulent, manipulative or deceptive conduct” on the basis discussed below.

Bars.

Our requests for comment focused on whether there was a need for the Commission to explicitly state that all orders that have the practical effect of a bar (prohibiting a person from engaging in a particular activity) should be treated as such, even if the relevant order did not call it a “bar.” We also requested comment on whether it would be appropriate to provide a cut-off date (for example, ten years) for permanent bars.

Several commenters urged us to provide additional guidance about what constitutes a bar.

131

We believe the statutory language is clear: bars are orders issued by one of the specified regulators that have the effect of barring a person from association with certain regulated entities; from engaging in the business of securities, insurance or banking; or from engaging in savings association or credit union activities. Any such order that has one of those effects is a bar, regardless of whether it uses the term “bar.” Orders that do not have any of those effects are not bars, although they may be disqualifying “final orders,” as discussed below.

131

See

comment letters from Alfaro; ABA Fed. Reg. Comm.; Rutledge; SIFMA; Whitaker Chalk.

Consistent with the proposal, the final rule provides that an order must bar the person “at the time of [the] sale” from one or more of the specified activities, to make clear that a bar is disqualifying only for as long as it has continuing effect.

132

Thus, for example, a person who was barred indefinitely, with the right to apply to reassociate after three years, would be disqualified until such time as he or she is permitted to reassociate, assuming that the bar had no continuing effect after reassociation. Several commenters argued that we should impose a cut-off date for permanent bars.

133

This would effectively treat permanent bars the same as other final orders, which are disqualifying only if issued during the look-back period. We are not, however, departing from the current standard under Rule 262 either by imposing a look-back period (making all regulatory bars issued within a specified period before a sale disqualifying, even if no longer in effect) or by imposing a cut-off date (which would make bars no longer disqualifying after the requisite time period has passed, even if the bar is permanent or otherwise still in effect). Under Rule 262, bars are disqualifying for as long as they are in effect but no longer, matching the period of disqualification to the duration of the regulatory sanction. We are adopting the same approach for Rule 506. Persons who are subject to an indefinite bar who do not wish to reassociate but do wish to participate in Rule 506 offerings could consider applying for a waiver.

132

This accords with the Commission's interpretive position on Rule 262.

See

Release No. 33-6289 (Feb. 13, 1981) [46 FR 13505, 13506 (Feb. 23, 1981)] (Commission consistently has taken the position that a person is “subject to” an order under Section 15(b), 15B(a) or (c) of the Exchange Act or Section 203(e) or (f) of the Advisers Act only so long as some act is being performed (or not performed) pursuant to the order).

See

note 156 and accompanying text.

133

See

comment letters from ABA Fed. Reg. Comm.; Katten Muchin; Lehman & Eilen; Rutledge; Schuyler, Roche & Crisham, P.C. (July 14, 2011) (“Schuyler Roche”); SIFMA.

We recognize that, in the proposal and in the final rule, the treatment of court injunctions and restraining orders, on one hand, and regulatory bars and orders, on the other hand, is different in some respects. Court injunctions and restraining orders are subject to a five-year look-back period, which functions as a cut-off (

i.e.,

injunctions and restraining orders issued more than five years before the relevant sale are no longer disqualifying, even if they are still in effect or permanent). The treatment of court injunctions and restraining orders is consistent with Rule 262, and therefore responds to the requirement to develop a “substantially similar” rule, while the treatment of regulatory bars and orders is specifically mandated by Section 926 of the Dodd-Frank Act. Commenters did not generally support harmonizing our approach to court injunctions and restraining orders with the mandated treatment of regulatory bars and orders, and we do not believe that the shift from Regulation A to Rule 506 offerings justifies extending the time period for disqualification associated with court injunctions and restraining orders.

Final Orders.

Section 926 of the Dodd-Frank Act does not specify what should be deemed to constitute a “final order” that triggers disqualification. The proposal included an amendment to Rule 501 to provide a definition of “final order,” based on the definition that the Financial Industry Regulatory Authority (“FINRA”) uses in forms that implement language in Section 15(b)(4)(H) of the Exchange Act, which is identical

134

to the language used in Section 926.

135

Under the proposal, “final order” would mean “a written directive or declaratory statement issued pursuant to applicable statutory authority and procedures by a federal or state agency described in § 230.506(c)(1)(iii), which constitutes a final disposition or action by that federal or state agency.”

134

Note, however, that Section 15(b)(4)(H) does not contain a look-back period, unlike the 10-year look-back period specified in Section 926(2)(A)(ii).

135

The definition of “final order” used by FINRA applies to Forms U4, U5 and U6, which are used for reporting the disciplinary history of broker-dealers and associated persons under Exchange Act Section 15(b)(4)(H). Form U4 is the Uniform Application for Securities Industry Registration or Transfer, used by broker-dealers to register associated persons. Form U5 is the Uniform Termination Notice for Securities Industry Registration, used by broker-dealers to report the termination of an associated person relationship. Form U6 is the Uniform Disciplinary Action Reporting Form, used by SROs and state and federal regulators to report disciplinary actions against broker-dealers and associated persons.

The proposing release requested comment on other potential approaches to the term “final order,” such as whether the rule should consider orders final only if they are non-appealable, and whether the rule should cover only orders issued in a process that provides for certain due process rights, such as notice, a right to be heard, and a requirement for a record with written findings of fact and conclusions of law. We also queried whether disqualifying matters that arose in the context of a settlement with a regulatory authority should be treated the same as non-settled matters. The proposing release also discussed whether the Commission should defer to the regulator issuing the order to determine whether the issued order was a “final order” for purposes of disqualification in Rule 506.

Several commenters agreed that a definition of “final order” would be helpful in promoting uniform and predictable treatment of regulatory actions.

136

Four commenters were generally supportive of the proposed definition.

137

136

See, e.g.,

letters from NYCBA; Rutledge; SIFMA.

137

Letters from C. Barnard; Rutledge; Better Markets; Munck Carter, LLP (July 14, 2011) (“Munck Carter”).

Two commenters suggested adding minimum procedural standards to the definition of “final order.”

138

One advocated building “basic due process elements” into the definition by adding the concept of notice and an opportunity for a hearing.

139

This commenter suggested that, in order to ensure that settled matters would be treated the same as litigated matters, the definition should require “an opportunity for hearing” rather than some specified actual proceeding.

140

The other commenter recommended that, for an order to constitute a “final order,” a regulator “must have made a

finding of fact and set forth conclusions of law on a record.”

141

138

Letters from NYCBA; SIFMA.

139

Letter from NYCBA.

140

Id.

141

Letter from SIFMA.

Taking into account the potential impact of disqualification on issuers and other market participants, we are persuaded that the definition of “final order” should be limited to orders issued under statutory authority—including statutes, rules and regulations—that provides for notice and an opportunity for hearing.

142

As a result, under our final definition,

ex parte

orders issued under statutory authority that does not provide for notice and an opportunity for hearing will not trigger disqualification. We are not, however, imposing procedural requirements beyond a basic requirement that notice and opportunity for hearing be provided for in the statutes, rules and regulations under which an order is issued. The proceedings covered in Rule 506(d)(1)(iii) take many different forms, and it would not be appropriate for our rules to impose procedural requirements that may not be met by the proceedings of every state or federal regulator whose orders are required to trigger disqualification under Section 926 of the Dodd-Frank Act. We are also not requiring that a hearing actually have occurred. There may be no hearing, for example, in the context of a settled matter; however a settlement is considered for this purpose to have been made after an opportunity for hearing. The basic requirement we have included should be sufficient to address the fundamental fairness concern.

142

See

Rule 501.

We believe that focusing on the nature of the relevant legal authority for an order rather than the particular facts and circumstances surrounding the order will provide more certainty to issuers seeking to determine whether a covered person subject to an order is in fact subject to a “final order” that would be disqualifying. An issuer would only need to determine whether the statutory authority provided for these procedural safeguards, not whether in fact notice was given and an opportunity for hearing was provided. This approach is consistent with comment we received stressing the importance of making the disqualification provisions clear and simple to administer, based on “bright line” provisions or an “objective test” wherever possible.

143

The focus on legal authority rather than the facts of each case will also likely reduce the incidence of covered persons, in an effort to participate in an offering, claiming procedural irregularities where such irregularities did not occur. A market participant that is subject to an order that was issued without in fact receiving notice and an opportunity for hearing will be able to challenge the order itself, and may also seek a waiver of disqualification from the Commission.

143

Letter from NYCBA

We do not believe that limiting final orders in this way will compromise investor protection because, in most instances,

ex parte

orders are of short duration and will either expire or be replaced by a subsequent order that would meet our procedural requirements.

Commenters were divided on the question of whether orders should be deemed final if they are still subject to appeal. Three commenters objected to adding a requirement that final orders be non-appealable, generally on the basis that the resulting delay could compromise investor protection.

144

Three other commenters argued that the definition of “final order” should be limited to non-appealable orders.

145

We remain concerned that delay incident to the appeals process could undermine the intended benefits of the rule, and are therefore adopting the definition of “final order” without a requirement that the order be non-appealable.

146

144

Letters from C. Barnard; NYCBA; Rutledge.

145

Letters from SIFMA; REISA; Alfaro.

146

See

Rule 501.

As adopted, the definition of “final order” contained in new Rule 501(g) provides that “final order” shall mean a written directive or declaratory statement issued by a federal or state agency described in § 230.506(d)(1)(iii) under applicable statutory authority that provides for notice and an opportunity for hearing, which constitutes a final disposition or action by that federal or state agency.

Fraudulent, Manipulative or Deceptive Conduct.

Section 926(2)(A)(ii) of the Dodd-Frank Act provides that disqualification must result from final orders of the relevant regulators that are “based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct.” In light of the specificity of the language of Section 926, the proposal did not include standards or guidance with respect to what constitutes “fraudulent, manipulative or deceptive conduct.”

In the proposing release we solicited comment on whether the rule should provide a definition for “fraudulent, manipulative or deceptive conduct” and, if we provided a definition, what should be included in such a definition. Recognizing that Section 926(2)(A)(ii) refers to the final orders of the relevant regulators, the proposing release also requested comment on whether the “fraudulent, manipulative or deceptive conduct” determination should be considered and decided only by the relevant regulator issuing the final order. In particular, we asked whether “fraudulent, manipulative or deceptive conduct” should be understood to require knowing misconduct or scienter, and noted the concern expressed by some commenters that “technical or administrative violations” should not be a source of disqualification.

147

See

advance comment letter from Investment Program Association (Mar. 2, 2011) (available at

http://www.sec.gov/comments/df-title-ix/regulation-d-disqualification/regulationddisqualification-3.pdf

See

also

Record of Proceedings of 29th Annual SEC Government-Business Forum on Small Business Capital Formation, at 18 (Nov. 18, 2010) (remarks of Deborah Froling) (available at

http://www.sec.gov/info/smallbus/sbforumtrans-111810.pdf

Some commenters believed that the Commission should provide standards for fraudulent, manipulative or deceptive conduct to clarify and limit the types of orders by state and federal regulators that will trigger disqualification.

148

These commenters supported a definition that requires scienter, generally modeled on the scienter standards of Section 10(b) of the Exchange Act and Rule 10b-5.

149

Many of these commenters also argued that violations they characterized as “technical” or “administrative,” such as late filings and books and records violations, without a requirement of scienter, should not give rise to disqualification.

150

On the other hand, a commenter who opposed defining “final order” to include scienter pointed out that scienter is not required for all state securities law violations or for violations of federal banking regulations (where the standard is unsafe or unsound banking practices or breach of fiduciary duty), so limiting the definition of fraudulent, manipulative or deceptive conduct to scienter-based violations would potentially result in orders by those regulators not giving rise to disqualification even though they are explicitly mandated to be covered by Section 926. In the commenter's view, this would be contrary to Congressional

intent and the plain language of Section 926.

151

148

See

comment letters from Alfaro; ABA Fed. Reg. Comm.; Five Firms; the Managed Funds Association (Aug. 12, 2011) (“MFA”); NYCBA; REISA; SIFMA; S&C; Whitaker Chalk.

149

See

comment letters from ABA Fed. Reg. Comm.; Five Firms; MFA; NYCBA; REISA; SIFMA; S&C; Whitaker Chalk.

See

also

comment letter from Cleary Gottlieb (supporting a scienter requirement for all regulatory orders, including orders of the Commission, with an exception for Commission orders related to violations of Section 5 of the Securities Act).

150

See, e.g.,

comment letters from Five Firms; MFA; SIFMA.

151

See

comment letter from Rutledge.

We do not believe that Section 926(A)(ii) is limited to matters involving scienter. Scienter is not a requirement under Section 15(b)(4)(H) of the Exchange Act or Section 203(e)(9) of the Advisers Act, from which the language of Section 926 is drawn. Commission orders are issued under these sections based only on the existence of a relevant state or federal regulatory order; the Commission has stated that, while the degree of scienter involved is a factor in determining what sanction is appropriate,

152

the Commission can order sanctions even where scienter is not an element of the underlying state anti-fraud law violation.

153

Scienter may also not play a similar role in other areas of regulation specified in Section 926(A)(ii), such as insurance, banking and credit union regulation, as it does under the federal securities laws. We do not believe it is appropriate to limit the provision to matters involving scienter absent a clear statutory direction to do so, particularly when the relevant language has been construed in other contexts not to be so limited, and when imposing such a limitation may result in excluding regulatory orders that are explicitly mandated to be covered by the new rules. Accordingly, the final rules do not include a definition of “fraudulent, manipulative or deceptive conduct” and in particular do not limit “fraudulent, manipulative or deceptive conduct” to matters involving scienter.

152

Steadman

SEC,

603 F.2d 1126, 1140 (5th Cir. 1979),

aff'd on other grounds,

450 U.S. 91 (1981).

153

See In the Matter of Mitchell M. Maynard and Dorice A. Maynard,

Release No. IA-2875 (May 15, 2009).

Final Rule. As adopted, Rule 506(d)(1)(iii) provides that disqualification will arise if a covered person is subject to a final order of a state securities commission (or an agency or officer of a state performing like functions); a state authority that supervises or examines banks, savings associations, or credit unions; a state insurance commission (or an agency or officer of a state performing like functions); an appropriate federal banking agency; the U.S. Commodity Futures Trading Commission; or the National Credit Union Administration that:

• At the time of the sale, bars the person from association with an entity regulated by such commission, authority, agency, or officer; engaging in the business of securities, insurance or banking; or engaging in savings association or credit union activities; or

• Constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before the sale.

154

Rule 506(d)(1)(iii).

4. Commission Disciplinary Orders

Rule 262(b)(3) of Regulation A imposes disqualification on an issuer if any covered person is subject to an order of the Commission “entered pursuant to section 15(b), 15B(a), or 15B(c) of the Exchange Act, or section 203(e) or (f) of the Investment Advisers Act.”

155

Under these provisions (other than Section 15B(a), discussed below), the Commission has authority to order a variety of sanctions against registered brokers, dealers, municipal securities dealers and investment advisers and their associated persons, including suspension or revocation of registration, censure, placing limitations on their activities, imposing civil money penalties and barring individuals from being associated with specified entities and from participating in the offering of any penny stock.

155

17 CFR 230.262(b)(3) (citing 15 U.S.C. 78o(f), 78o(4)(a), 78o(4)(c), 80b-3(e) and 80b-3(f)). Section 21B(a) of the Exchange Act, 15 U.S.C. 78u-2(a)(1), and Section 203(i)(1)(A) of the Advisers Act, 15 U.S.C. 80b-3(i)(1)(A), give the Commission authority to impose civil money penalties in these disciplinary proceedings.

Our proposed rule was based on Rule 262(b)(3), but eliminated the anomalous reference to Section 15B(a), which is not a source of sanctioning authority, and codified the prior interpretive position that disqualification would continue only for as long as some act is prohibited or required to be performed pursuant to the order (with the consequence that censures and orders to pay civil money penalties, assuming the penalties are paid in accordance with the order, are not disqualifying, and a disqualification based on a suspension or limitation of activities expires when the suspension or limitation expires).

156

Under the proposed rule, an offering would be disqualified if any covered person is subject to an order of the Commission entered pursuant to section 15(b) or 15B(c) of the Exchange Act or section 203(e) or (f) of the Advisers Act that, at the time of such sale, suspends or revokes such person's registration as a broker, dealer, municipal securities dealer or investment adviser; places limitations on the activities, functions or operations of such person; or bars such person from being associated with any entity or from participating in the offering of any penny stock.

157

156

See

Proposed Rule 506(c)(1)(iv); Release No. 33-6289 (Feb. 13, 1981) [46 FR 13505, 13506 (Feb. 23, 1981)] (in adopting amendments to Rule 252 of Regulation A, the predecessor to Rule 262, the Commission noted “[i]n those instances where persons are subject to orders containing no definite time limitations, the Commission has consistently taken the position that a person is subject to an order only so long as some act is being performed pursuant to such order, [such as] establishing procedures to assure appropriate supervision of salesmen and reporting on such procedures.”) The staff of the Division of Corporation Finance has taken the same view.

See

Release No. 33-6455, Question 66 (Mar. 3, 1983) [48 FR 10045, 10053 (Mar. 10, 1983)] (in interpretive release on Regulation D, the staff advised that censure has no continuing force and thus censured person is not “subject to an order of the Commission entered pursuant to section 15(b)” within the meaning of Rule 505); Howard, Prim, Rice, Nemerovski, Canady & Pollak, SEC No-Action Letter, 1975 WL 11300 (Jan. 8, 1975, publicly available Feb. 11, 1975) (Rule 252 does not comprehend a situation where an underwriter of a Regulation A offering has stipulated to a consent order in a Commission administrative proceeding providing only for a censure, with no suspension or other sanction); Samuel Beck, SEC No-Action Letter, 1975 WL 11471 (May 15, 1975, publicly available June 24, 1975).

157

Proposed Rule 506(c)(iv).

We requested comment on the appropriateness of codifying the interpretive position and imposing any look-back period for Commission disciplinary sanctions. Specifically, we requested comment on whether the rules should provide that orders to pay civil money penalties are disqualifying if the penalties are not paid as ordered. The proposal drew relatively little comment, all of which was supportive.

158

We are adopting the rule as proposed, now numbered Rule 506(d)(1)(iv).

158

See

comment letter from Rutledge;

see also

comment letters from Lehman & Eilen; SIFMA.

5. Certain Commission Cease-and-Desist Orders

Section 926 of the Dodd-Frank Act mandates that bad actor disqualification result from final orders issued within a ten-year period by the state and federal regulators identified in Section 926(2)(A) of the Dodd-Frank Act. The state and federal regulators listed in Section 926 include: State authorities that supervise banks, savings associations, or credit unions; state insurance regulators; appropriate federal banking agencies; and the National Credit Union Administration. The Commission is not included in the Section 926(2)(A) list of regulators. Although we did not propose specific amendments to the rule to include the Commission, we explained that adding the Commission's cease-and-desist orders to the disqualification provisions could further enhance the investor protection intent of the disqualification provisions and would contribute to creating an internally consistent set of rules that would treat relevant sanctions

similarly for disqualification purposes. In the proposing release, we pointed out in particular that orders issued in stand-alone Commission cease-and-desist proceedings

159

are not disqualifying under current bad actor disqualification provisions,

160

and the proposal did not include such orders as disqualifying for purposes of Rule 506 offerings.

159

In cease-and-desist proceedings, the Commission can issue orders against “any person,” including entities and individuals outside the securities industry, imposing sanctions such as penalties, accounting and disgorgement or officer and director bars. In contrast, administrative proceedings are generally limited to regulated entities and their associated persons.

160

Current provisions also do not cover other types of Commission actions. For example, the Commission has authority under Section 9(b) of the Investment Company Act to bring proceedings against “any person” and may impose investment company bars, civil penalties and disgorgement under Sections 9(d) and (e) of the Investment Company Act. 15 U.S.C. 80a-9(b), (d) and (e). The Commission also has authority under Rule 102(e) of its Rules of Practice to censure persons (such as accountants and attorneys) who appear or practice before it, or to deny them the privilege of appearing before the Commission temporarily or permanently. 17 CFR 201.102(e). Orders under these sections are not disqualifying under Rule 262.

Our request for comment covered a range of issues, including whether it was appropriate to include the Commission in the list of regulators and if so, what types of Commission cease-and-desist orders should give rise to Rule 506 disqualification. In the proposing release, we presented possible approaches to including Commission orders as a disqualifying event and requested comment on those approaches. We requested comment on whether it would be appropriate to include cease-and-desist orders issued by the Commission for violations of the anti-fraud provisions of the federal securities laws, and whether requiring scienter and including cease-and-desist orders related to violations of Section 5 of the Securities Act would be appropriate. Given that Rule 506 offerings provide an exemption from Section 5 registration, we noted that on that basis, persons who violate Section 5 should potentially lose the benefit of exemptive relief for some period afterward.

The request for comment generated a substantial response. Five comment letters favored covering all Commission orders, including cease-and-desist orders (subject in some cases to a scienter requirement).

161

One comment letter noted that although including Commission cease-and-desist orders could impair capital formation, the benefits of doing so would outweigh the risks because adding Commission orders would more effectively work to screen out bad actors and improve internal consistency of the rules.

162

This comment letter described the proposed rule and the absence of Commission orders as “under-inclusive” because the proposed amendments did not explicitly address all final orders issued by the Commission addressing fraudulent, manipulative or deceptive conduct.

161

See

comment letters from Better Markets; Cleary Gottlieb (scienter required except for Section 5 violations); NYCBA; NASAA; Whitaker Chalk (scienter required; suggesting that Commission list the violations that lead to disqualification or adopt a willful violation standard).

162

See

comment letter from Cleary Gottlieb.

Five comment letters opposed adding Commission cease-and-desist orders, generally arguing that the Commission lacks authority to expand on the Section 926 statutory scheme in that way.

163

One comment letter suggested the decision to include cease-and-desist orders would add a large class of regular and routine disciplinary proceedings to the disqualification provisions, expressing concern that including administrative cease-and-desist orders that do not require any showing or finding of intentional misconduct could be viewed as unnecessarily punitive by disqualifying an organization from particular types of capital formation activity.

164

This comment letter also noted that including cease-and-desist orders marked a departure from the disciplinary order provisions of Rule 262(b)(3) in which the Commission has historically interpreted Rule 262 “to require disqualification only for as long as some act is prohibited or required to be performed pursuant to the order.”

165

Another comment letter stated that cease-and-desist orders should not create a disqualification unless it imposes a limitation or restriction on conduct.

166

One commenter also opposed adding Commission cease-and-desist orders based on the legislative history of Section 15(b)(4)(H) of the Exchange Act, from which the language used in Section 926 is drawn.

167

163

See

comment letters from ABA Fed. Reg. Comm.; Five Firms; Katten Muchin; Rutledge; SIFMA.

164

See

comment letter from Five Firms.

165

Id.

166

See

comment letter from SIFMA.

167

See

comment letter from Rutledge.

We believe that including certain Commission cease-and-desist orders in the bad actor disqualification scheme would enhance its investor protection benefits and make the overall scheme of Rule 506 of Regulation D more internally consistent. We believe an injunctive or restraining order issued by a federal court and a Commission cease-and-desist order arising out of the same legal violation equally demonstrate disqualifying conduct and should have the same consequences under our disqualification rules. The benefits associated with screening bad actors out of the Rule 506 market should not depend on whether a particular enforcement action is brought in court or through a Commission cease-and-desist proceeding. For that reason, the final rules include a provision that makes certain Commission cease-and-desist orders a disqualifying event.

We disagree with the commenters who argue that the Commission lacks authority, as part of this rulemaking, to add additional disqualification triggers not provided in Section 926. In our view, Section 926 does not limit the existing authority we previously used to create other bad actor provisions.

In expanding the list of disqualification triggers beyond those required in Section 926, we are mindful of our mandate to promote investor protection and capital formation. In particular, we are mindful of the concerns expressed by commenters about the potentially negative impact on capital raising of overbroad disqualification standards.

168

The concerns associated with including Commission cease-and-desist orders involved expanding the class of covered persons subject to disqualification and including administrative cease-and-desist orders that do not require any showing or finding of scienter. With those issues in mind, the additional disqualification trigger we are adopting covers only Commission orders to cease and desist from violations and future violations of the scienter-based anti-fraud provisions of the federal securities laws (including, without limitation, Section 17(a)(1) of the Securities Act,

169

Section 10(b) of the Exchange Act

170

and Rule 10b-5 thereunder,

171

Section 15(c)(1) of the Exchange Act,

172

and Section 206(1) of the Advisers Act

173

) and violations of Section 5 of the Securities Act.

174

The additional disqualification trigger for Section 5 violations will not require scienter, which is consistent with the strict liability standard imposed by Section 5.

175

As a policy matter, we do not believe that exemptions from

registration based on Rule 506 should be available to persons whose prior conduct has resulted in an order to cease and desist from violations of Section 5's registration requirements.

168

See

notes 296-98 and accompanying text.

169

15 U.S.C. 77q(a)(1).

170

15 U.S.C. 78j(b).

171

17 CFR 240.10b-5.

172

15 U.S.C. 78o(c)(1).

173

15 U.S.C. 80b-6(1).

174

15 U.S.C. 77e.

175

See SEC

North American Research and Development Corp.,

424 F.2d 63, 8182 (2d Cir. 1970);

Swenson,

626 F.2d at 424 (5th);

SEC

Ross,

504 F.3d 1130, 1137 (9th Cir. 2007);

SEC

Pearson,

426 F.2d 1339, 1343 (10th Cir. 1970).

The additional disqualification trigger will be subject to the same five-year look-back period that applies to court restraining orders and injunctions,

176

rather than the 10-year look-back that is mandated to apply to other regulatory orders under Section 926, which will provide consistent Commission treatment of cease and desist orders with court orders.

176

Rule 506(d)(1)(ii).

As adopted, Rule 506(d)(1)(v) imposes disqualification if any covered person is subject to any order of the Commission entered within five years before such sale that, at the time of such sale, orders the person to cease and desist from committing or causing a violation or future violation of any scienter-based anti-fraud provision of the federal securities laws (including without limitation Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Section 15(c)(1) of the Exchange Act and Section 206(1) of the Advisers Act, or any other rule or regulation thereunder) or Section 5 of the Securities Act.

177

Rule 506(d)(1)(v).

6. Suspension or Expulsion From SRO Membership or Association With an SRO Member

Rule 262(b)(4) disqualifies an offering if any covered person is suspended or expelled from membership in, or suspended or barred from association with a member of, a securities self-regulatory organization or “SRO” (

i.e.,

a registered national securities exchange or national securities association) for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade.

178

The proposed rule added a reference to a registered affiliated securities association and applied the standard to all covered persons,

179

but did not otherwise change the substance of the rule. Under the proposed rule, an offering would be disqualified if any covered person is suspended or expelled from membership in, or suspended or barred from association with a member of, a registered national securities exchange or a registered national or affiliated securities association for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade.

180

178

See

17 CFR 230.262(b)(4).

179

Proposed Rule 506(c)(1)(vi). Rule 262(b)(4) does not apply to issuers and their predecessors and affiliated issuers. 17 CFR 230.262(b)(4).

180

Proposed Rule 501(c)(v).

The proposal drew little comment,

181

and we are adopting the text of the rule as proposed. It is now numbered Rule 506(d)(1)(vi) because of the addition of the new provision covering certain Commission cease-and-desist orders in Rule 506(d)(1)(v).

181

Three commenters responded to our request for comment on whether commodities exchanges and commodities self-regulatory organizations should be covered by the provision. One favored such an extension (comment letter from Better Markets) and two opposed it (comment letters from Lehman & Eilen, Rutledge). We have not included such an extension in the final rule.

7. Stop Orders and Orders Suspending the Regulation A Exemption

Paragraphs (a)(1) and (2) of Rule 262 impose disqualification on an offering if the issuer, or any predecessor or affiliated issuer, has filed a registration statement or Regulation A offering statement that was the subject of a Commission refusal order, stop order or order suspending the Regulation A exemption within the last five years, or is the subject of a pending proceeding to determine whether such an order should be issued.

182

Similarly, paragraphs (c)(1) and (2) impose disqualification if any underwriter of the securities proposed to be issued was, or was named as, an underwriter of securities under a registration statement or Regulation A offering statement that was the subject of a Commission refusal order, stop order or order suspending the Regulation A exemption within the last five years, or is the subject of a pending proceeding to determine whether such an order should be issued.

183

The proposed rule incorporated the substance of these four paragraphs in a single paragraph that applied to all covered persons. Under the proposed rule, an offering would be disqualified if any covered person has filed (as a registrant or issuer), or was or was named as an underwriter in, any registration statement or Regulation A offering statement filed with the Commission that, within five years before such sale, was the subject of a refusal order, stop order, or order suspending the Regulation A exemption, or is, at the time of such sale, the subject of an investigation or proceeding to determine whether a stop order or suspension order should be issued.

184

182

17 CFR 230.262(a)(1) and (2).

183

17 CFR 230.262(c)(1) and (2).

184

Proposed Rule 506(c)(1)(vi).

The proposal drew only one comment,

185

which supported the proposal, and we are adopting the text as proposed, now numbered Rule 506(d)(1)(vii).

185

See

comment letter from Rutledge.

8. U.S. Postal Service False Representation Orders

Paragraphs (a)(5) and (b)(5) of Rule 262 impose disqualification on an offering if the issuer or another covered person is subject to a U.S. Postal Service false representation order entered within the preceding five years, or to a temporary restraining order or preliminary injunction with respect to conduct alleged to have violated the false representation statute that applies to U.S. mail.

186

Our proposed rule incorporated the substance of these paragraphs in a single paragraph, disqualifying an offering if any covered person is subject to a United States Postal Service false representation order entered within five years before such sale, or is, at the time of such sale, subject to a temporary restraining order or preliminary injunction with respect to conduct alleged by the United States Postal Service to constitute a scheme or device for obtaining money or property through the mail by means of false representations.

187

The proposal drew only one comment,

188

which supported the proposal, and we are adopting the text as proposed, now numbered Rule 506(d)(1)(viii).

186

Paragraph (a)(5) relates to issuers and their predecessors and affiliated issuers, and paragraph (b)(5) relates to other covered persons. Disqualification results if any covered person “is subject to a United States Postal Service false representation order entered under 39 U.S.C. 3005 within 5 years prior to the filing of the offering statement, or is subject to a temporary restraining order or preliminary injunction entered under 39 U.S.C. 3007 with respect to conduct alleged to have violated 39 U.S.C. 3005.” 17 CFR 230.262(a)(5) and (b)(5).

187

Proposed Rule 506(c)(1)(vii)

188

See

comment letter from Rutledge.

D. Reasonable Care Exception

1. Reasonable Care Standard

The proposal included an exception from disqualification for offerings where the issuer establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed because of the presence or participation of another covered person.

189

See

Proposed Rule 506(c)(2)(ii).

The proposal also included an instruction to the reasonable care exception explaining that an issuer would not be able to establish that it had exercised reasonable care unless it made a factual inquiry into whether any disqualifications existed. As proposed, the instruction noted that the nature and scope of the inquiry would vary based

on the circumstances of the issuer and the other offering participants. We proposed the reasonable care exception to preserve the intended benefits of Rule 506 and avoid creating an undue burden on capital-raising activities, by reducing the risk that issuers could lose the benefit of Rule 506 as a result of disqualifications of which they were unaware.

190

Rule 508 of Regulation D provides that “insignificant deviations” from the terms, conditions and requirements of Regulation D will not necessarily result in loss of the exemption from Securities Act registration requirements. Rule 508 provides that the exemption will not be lost with respect to any offer or sale to a particular individual or entity as a result of a failure to comply with a term, condition or requirement of Regulation D if the person relying on the exemption shows that: the failure to comply did not pertain to a term, condition or requirement directly intended to protect that particular individual or entity; the failure to comply was insignificant with respect to the offering as a whole (provided that certain Regulation D requirements, including limitations on general solicitation and any applicable limits on the amount of securities offered and the number of investors, are always deemed significant); and a good faith and reasonable attempt was made to comply. 17 CFR 230.508. We do not believe that Rule 508 would cover circumstances in which an offering was disqualified based on Rule 506(d).

The proposing release did not prescribe or delineate what steps an issuer would be required to take to show reasonable care. Rather, it noted that the steps an issuer would take would vary according to the circumstances of the covered persons and the offering, taking into account the risk of having a bad actor, the impact of other screening and compliance mechanisms already in place, and the cost and burden of the inquiry. We requested comment on the appropriateness of the reasonable care exception and whether the rule should specify what factual inquiry is required or provide examples of specific factual inquiries that would be deemed to constitute reasonable care. The proposing release also recognized that requiring large issuers or large financial institutions acting as compensated solicitors to conduct factual inquiries on potentially lengthy lists of officers could be burdensome, and therefore we requested comment on whether the rules should provide specific steps to establish reasonable care in these circumstances.

In the proposing release, we discussed the reasonable care exception in the NASAA-approved Model Accredited Investor Exemption (“MAIE”), which serves as a standard in blue sky law and has been adopted in some form by a majority of the states. The MAIE requires the issuer to conduct a “factual inquiry” before asserting the reasonable care exception but does not provide specific information on what steps are required for the factual inquiry. We also noted in the proposing release that, as part of the proposed amendments to Regulation D in 2007, the Commission proposed disqualification provisions that included a reasonable care exception based on the MAIE, without any express reference to factual inquiry.

The proposed reasonable care exception attempted to address the potential difficulty for issuers in establishing whether any covered persons are the subject of disqualifying events, particularly given that there is no central repository that aggregates information from all the federal and state courts and regulatory authorities that would be relevant in determining whether covered persons have a disqualifying event in their past. We believe such a reasonable care exception will facilitate the continued utility of Rule 506 in light of the new disqualification requirements.

Commenters who addressed the issue were unanimous in their support for a reasonable care exception.

191

Many, however, voiced concerns about the perceived vagueness of the proposed exception, and urged us to provide more guidance on what types of factual inquiry would constitute compliance.

192

Some commenters suggested that specific steps be presumed to establish reasonable care, such as obtaining questionnaires from appropriate persons (provided the issuer has no knowledge of undisclosed disqualifying events)

193

or use of a reputable background investigations firm.

194

Another suggested that issuers be permitted to rely on contractual representations from registered broker-dealers and other regulated entities, and that broker-dealers that adopt reasonable policies and procedures to identify disqualifications in respect of other offering participants should be presumed to satisfy the “reasonable care” test.

195

One commenter requested a cut-off date for the determination of bad actor involvement (

e.g.,

15 days before commencement of the offering).

196

Three commenters who supported the reasonable care exception criticized the proposed factual inquiry requirement, suggesting it would impose undue burdens on issuers and recommending that we remove it from the adopted rule.

197

Another commenter suggested that the Commission look to the standards that were adopted by NASAA in the Uniform Limited Offering Exemption and endorsed by NASAA in the Uniform Securities Act, neither of which contains a factual inquiry component.

198

191

See, e.g.,

comment letters from ABA Fed. Reg. Comm.; Angel Capital Association (July 14, 2011) (“Angel Capital Comment Letter 1”); Better Markets; DTC; Kutak Rock; Lehman & Eilen; NASAA; NYCBA; Rutledge; SIFMA; Seward & Kissel; S&C; S&W; Whitaker Chalk.

192

See, e.g.,

comment letters from ABA Fed. Reg. Comm.; Kutak Rock; NYCBA; S&C.

193

See

Angel Capital Comment Letter 1;

see also

comment letter from ABA Fed. Reg. Comm..

194

See

comment letter from S&W.

195

See

comment letter from NYCBA;

see also

comment letters from ABA Fed. Reg. Comm.; Angel Capital Comment Letter 1; Kutak Rock (issuers should be able to rely on registered broker-dealer's confirmation that no disqualification exists).

196

See

comment letter from Cleary Gottlieb.

197

See

Angel Capital Comment Letter 1;

see also

comment letters from Rutledge; S&C.

198

Comment letter from Rutledge. The Uniform Limited Offering Exemption and the Uniform Securities Act provide exceptions from disqualification where the issuer shows that it did not know and in the exercise of reasonable care could not have known that a disqualification existed.

Other commenters stressed the importance of conditioning the availability of the reasonable care exception on the issuer's factual inquiry.

199

These commenters viewed the factual inquiry as a way to ensure that investor protection is not compromised by issuers' taking minimal steps designed primarily to satisfy minimum requirements for the reasonable care standard rather than to ascertain whether disqualifications actually apply.

200

199

See

comment letters from Better Markets; NASAA.

200

E.g.,

comment letter from Better Markets.

We continue to believe that the concept of reasonable care necessarily includes inquiry by the issuer into the relevant facts, and we are adopting the provision and its accompanying instruction substantially as proposed.

201

There is a wide range of issuers involved in Rule 506 offerings, from large reporting companies, to private investment funds, to smaller private companies, all of which have different legal and ownership structures and may employ a wide range of financial intermediaries, in terms of size, number of employees and scope. As a result, we do not believe it is appropriate to prescribe specific steps as being necessary or sufficient to establish reasonable care.

201

See

Rule 506(d)(2)(iii) and instruction thereto.

Accordingly, as we stated in the proposing release, the steps an issuer should take to exercise reasonable care will vary according to the particular facts and circumstances. For example, we anticipate that issuers will have an in-depth knowledge of their own executive officers and other officers participating in securities offerings gained through the hiring process and in the course of the employment relationship, and in such circumstances,

further steps may not be required in connection with a particular offering. Factual inquiry by means of questionnaires or certifications, perhaps accompanied by contractual representations, covenants and undertakings, may be sufficient in some circumstances, particularly if there is no information or other indicators suggesting bad actor involvement.

The timeframe for inquiry should also be reasonable in relation to the circumstances of the offering and the participants. Consistent with this standard, the objective should be for the issuer to gather information that is complete and accurate as of the time of the relevant transactions, without imposing an unreasonable burden on the issuer or the other participants in the offering. With that in mind, we expect that issuers will determine the appropriate dates to make a factual inquiry, based upon the particular facts and circumstances of the offering and the participants involved, to determine whether any covered persons are subject to disqualification before seeking to rely on the Rule 506 exemption.

In general, issuers should make factual inquiry of the covered persons, but in some cases—for example, in the case of a registered broker-dealer acting as placement agent—it may be sufficient to make inquiry of an entity concerning the relevant set of covered officers and controlling persons, and to consult publicly available databases concerning the past disciplinary history of the relevant persons.

202

Broker-dealers are already required to obtain much of this information for their own compliance purposes. We anticipate that financial intermediaries and other market participants will develop procedures for assisting issuers in gathering the information necessary to satisfy the issuer's factual inquiry requirement.

202

FINRA maintains BrokerCheck, an online tool that enables the public to check the professional backgrounds of current and former FINRA-registered brokerage firms and brokers, as well as investment adviser firms and representatives. The information included in BrokerCheck about brokers and brokerage firms is derived from the Central Registration Depository, the securities industry online registration and licensing database. The information about investment adviser firms and representatives made available through BrokerCheck is derived from the Commission's Investment Adviser Public Disclosure (IAPD) database.

If the circumstances give an issuer reason to question the veracity or accuracy of the responses to its inquiries, then reasonable care would require the issuer to take further steps or undertake additional inquiry to provide a reasonable level of assurance that no disqualifications apply.

2. Continuous and Long-Lived Offerings

Some commenters requested specific guidance from the Commission on factual inquiry procedures for continuous offerings such as those by hedge funds and some other pooled investment funds.

203

One commenter criticized the application of the factual inquiry requirement to offerings made on a continuous or delayed basis under Rule 506, arguing that reasonable factual inquiry for all covered persons could be interpreted to require continuous, real-time monitoring, which would be especially onerous for issuers in such offerings.

204

Others suggested permitting issuers to establish the reasonable care exception solely through an initial representation about the potential applicability of disqualifying events followed by subsequent periodic updates, such as annual negative consent letters relating to any changes to such representation on a basis consistent with FINRA Rules 5130 and 5131.

205

203

See

comment letters from Lehman & Eilen; NYCBA; S&C.

204

See

comment letter from S&C.

205

See

comment letters from ABA Fed. Reg. Comm.; SIFMA; S&C;

see also

comment letter from NYCBA (semi-annual updates). FINRA Rules 5130 and 5131 permit reliance on written representations for up to 12 months, with annual negative consent letters thereafter, to confirm that accounts are not beneficially owned by certain “restricted persons” (Rule 5130) or by certain executive officers and directors or persons materially supported by them (Rule 5131).

We believe that for continuous, delayed or long-lived offerings, reasonable care includes updating the factual inquiry on a reasonable basis. Again, the frequency and degree of updating will depend on the circumstances of the issuer, the offering and the participants involved, but in the absence of facts indicating that closer monitoring would be required (for example, notice that a covered person is the subject of a judicial or regulatory proceeding or knowledge of weaknesses in an organization's screening procedures), we would expect that periodic updating could be sufficient. We expect that issuers will manage this through contractual covenants from covered persons to provide bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.

E. Waivers

Consistent with the requirement of Section 926 that the Commission promulgate disqualification provisions “substantially similar” to Regulation A, the proposal included a waiver provision based on current Rule 262, under which the Commission could grant a waiver of disqualification if it determined that the issuer had shown good cause “that it is not necessary under the circumstances that the [registration] exemption . . . be denied.”

206

Proposed Rule 506(c)(2)(i).

The proposing release requested comment on whether the proposed rule should include a provision such as in the one in the MAIE that provides an exception from disqualification if the state authority that issued the disqualifying order waives the disqualification. The proposing release also requested comment on whether the Commission should provide guidance as to the circumstances that would likely give rise to the grant or denial of a waiver and whether the Commission should exercise waiver authority for cases involving final orders of state regulators.

1. Waiver for Good Cause Shown

Under current rules, the Commission has delegated authority to grant disqualification waivers under Regulation A and Rule 505 to the Director of the Division of Corporation Finance.

207

Under the proposal, there would have been no delegation of authority for waivers of bad actor disqualification under the new Rule 506 disqualification provisions, and all such waivers would have been issued by a direct order of the Commission.

207

See

17 CFR 200.30-1(b), 200.30-1(c).

Commenters who addressed the issue were universally supportive of including a waiver provision in the bad actor disqualification provisions applicable to Rule 506.

208

We are adopting the waiver provision substantially as proposed, with the modifications discussed below.

209

208

See

comment letters from ABA Fed. Reg. Comm.; Coy Capital; DTC; Five Firms; IPA; Katten Muchin; Lehman & Eilen Cotter; I. Linder (July 14, 2011); MFA; NYCBA; NASAA; REISA; Rutledge; SIFMA; Seward & Kissel; S&C; Whitaker Chalk.

209

See

Rule 506(d)(2)(ii).

Given the expectation of a short time frame for many Rule 506 offerings, a number of commenters expressed concern over the timeliness of waiver application reviews by the Commission and the risk that a lengthy review process may disadvantage issuers seeking speedy access to capital.

210

Three commenters urged that authority be delegated to Commission staff to grant waivers, out of a concern for

potential delays.

211

We are sensitive to concerns about delay in the waiver process, and believe that the staff has managed the process of granting waivers from Regulation A and Rule 505 disqualification appropriately in the past. Accordingly, we have determined to clarify the existing delegation of authority to the Director of the Division of Corporation Finance by amending it to cover waivers of Rule 506 disqualification.

212

210

See

comment letters from IPA; Seward & Kissel; Whitaker Chalk.

211

See

comment letters from ABA Fed. Reg. Comm.; MFA; Seward & Kissel.

212

See

17 CFR 200.30-1(c).

Several commenters requested clear guidance on circumstances that would give rise to the grant of a waiver from disqualification.

213

Three commenters argued that having clear disqualification waiver guidelines would result in greater efficiency for market participants and Commission staff, and encouraged the development of uniform standards that would prevent unfair application of the disqualification provisions.

214

We believe it would be premature to attempt to articulate standards for granting waivers, although we may consider doing so after we and the Commission staff have developed experience in handling waiver requests under the new Rule 506 disqualification rules. We have, nonetheless, identified in this adopting release a number of circumstances (such as a change of control, change of supervisory personnel, absence of notice and opportunity for hearing, and relief from a permanent bar for a person who does not intend to apply to reassociate with a regulated entity) that could, depending on the specific facts, be relevant to the evaluation of a waiver request. This is not an exhaustive list, and we expect that other factors would also be relevant to our consideration of waiver requests in particular cases.

213

See

comment letters from ABA Fed. Reg. Comm.; DTC; Lehman & Eilen; MFA; Rutledge; Whitaker Chalk.

214

See

comment letters from ABA Fed. Reg. Comm.; MFA; Rutledge.

2. Waiver Based on Determination of Issuing Authority

In response to our request for comment on how the Commission should handle waiver applications involving final orders of state regulators, three commenters recommended that the Commission retain its authority to waive disqualification arising out of such orders.

215

One commenter recommended that waivers should be permitted to be determined by the state or local authorities or the Commission, at the option of the issuer.

216

Several commenters recommended adoption of automatic exceptions from disqualification similar to those in the MAIE and Uniform Limited Offering Exemption (“ULOE”).

217

Under both the MAIE and ULOE, bad actor disqualification is waived if either (i) the person against whom an order is issued is licensed or regulated in the relevant state and is still permitted to conduct securities-related work in the state, or (ii) the regulator issuing the relevant order determines that disqualification is not necessary under the circumstances.

218

Another commenter recommended that the Commission not grant a waiver if such a grant would be prejudicial to an action by the state or regulator.

219

215

See

comment letters from ABA Fed. Reg. Comm.; Coy Capital; NYCBA.

216

See

comment letter from REISA.

217

See

comment letters from ABA Fed. Reg. Comm.; Five Firms; IPA; I. Linder; Rutledge; SIFMA; Whitaker Chalk;

see also

comment letter from NYCBA. The Uniform Limited Offering Exemption was adopted by NASAA in 1983 and again in 1989. It is designed to provide a state-level exemption for offerings that are exempt from registration at the federal level under Rule 505 of Regulation D. Peter M. Fass and Derek A. Wittner,

Blue Sky Practice for Public and Private Direct Participation Offerings,

§ 9.19 and Appendix 9A (Thomson Reuters/West 2008).

218

See

MAIE paragraphs (D)(2)(a)-(b) (available at

http://www.nasaa.org/wp-content/uploads/2011/07/24-Model_Accredited_Investor_Exemption.pdf

)

and

Fass and Wittner, note 205, at Appendix 9A, paragraph B.6.

219

See

comment letter from NASAA.

We are persuaded that the second leg of the MAIE/ULOE exception to disqualification, under which disqualification does not apply if the regulator issuing the relevant order determines that Rule 506 disqualification is not necessary under the circumstances, strikes an appropriate balance. It allows the relevant authorities to determine the impact of their orders and conserves Commission resources (which might otherwise be devoted to consideration of waiver applications) in cases where the relevant authority determines that disqualification from Rule 506 offerings is not warranted. Accordingly, the final rule contains a provision based on MAIE paragraph (D)(2)(b), under which disqualification will not arise if, before the relevant sale is made in reliance on Rule 506, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing, whether in the relevant judgment, order or decree or separately to the Commission or its staff, that disqualification under Rule 506 should not arise as a consequence of such order, judgment or decree.

220

Because disqualification will not arise in those circumstances, no waiver need be sought from the Commission for a person subject to such an order, judgment or decree to participate in a Rule 506 offering. Even in the absence of such advice, however, the Commission may still exercise its discretion to grant waivers under Rule 506(d)(2)(ii) in cases where it considers it appropriate to do so.

221

220

See

Rule 506(d)(2).

221

Conversely, in cases where disqualification does not arise on the basis of an order, judgment or decree because the issuing authority advises that it should not, the Commission would not be precluded from pursuing its own enforcement action, which may result in a court order or judgment or a Commission order that constitutes an independent basis for disqualification.

We are not, however, including a provision based on the first leg of the MAIE/ULOE test, which prevents disqualification if the triggering event occurs with respect to a regulated person, such as a broker-dealer, and such person continues to be licensed or registered to conduct securities-related business in the relevant state. As a practical matter, this approach eliminates from the MAIE/ULOE disqualification scheme all orders that are not bars or revocation of registration or licensure. We believe such an approach would be incompatible with the language of Section 926, which, by its terms, covers both bars and other final orders. For that reason, we have not adopted it. We may, however, take the fact that registration or licensure has not been suspended or revoked into account when considering waiver applications.

F. Transition Issues

1. Disqualification Applies Only to Triggering Events That Occur After Effectiveness of the Rule Amendments

Under the proposal, the new disqualification provisions would have applied to all sales made under Rule 506 after the effective date of the rule amendments. Offerings made after the effective date would have been subject to disqualification for all disqualifying events that occurred within the relevant look-back periods, regardless of whether the events occurred before enactment of the Dodd-Frank Act, or the proposal or effectiveness of the amendments to Rule 506.

We requested comment on this approach, both in broad terms and as to specific aspects, such as whether we should make special provision for orders issued in the context of negotiated settlements and whether we should provide for extensions of waivers granted with respect to bad actor disqualification under Regulation A, Rule 505 of Regulation D or

Regulation E, so they would apply to Rule 506 disqualification as well. This section of the proposing release drew more comment than any other.

Five commenters supported including prior bad actor disqualifying events in the disqualification provisions, generally arguing, on investor protection grounds, that the purpose of the rule is to prevent all bad actors from participating in Rule 506 offerings.

222

For example, one such commenter asserted, “[a]s between issuers and investors, it is far preferable that issuers face the delays or inconvenience necessary to cure disqualifications or register their offerings than for investors to be victimized by an issuer or promoter that was demonstrably unfit to invoke the Rule 506 exemption.”

223

One commenter argued that contested proceedings should not be grandfathered because in those cases the respondent had no choice in the ultimate result of the proceeding.

224

222

See

comment letters from Anonymous (July 12, 2011); Better Markets; J. Davis (June 13, 2011); DTC; NASAA.

223

See

comment letter from Better Markets.

224

See

comment letter from Lehman & Eilen.

On the other hand, 15 comment letters requested that the Commission not apply the rules to past triggering events, or else provide for widespread grandfathering.

225

Critics of applying the rules to past events objected on the basis of statutory construction,

226

the Supreme Court decision in

Landgraf

USI Film Products,

227

and Congressional intent.

228

Many commenters also argued that such application of the new disqualification rules would unfairly upset previously negotiated civil and administrative settlements, or impose an unforeseeable new sanction in respect of prior conduct.

229

Several commenters recommended providing automatic waivers for settlements, or automatic extension of existing Regulation A and Rule 505 waivers if the new rules were to be applied to pre-existing events.

230

Another commenter argued that prospective application of disqualification provisions would be consistent with the Commission's approach to analogous bad actor disqualification provisions in the past, such as the “ineligible issuer” provisions of the Securities Offering Reform rule adopted in 2005 and the disqualification provisions adopted under the Private Securities Litigation Reform Act of 1995.

231

225

See

comment letters from Alfaro; ABA Fed. Reg. Comm.; Cleary Gottlieb; Coy Capital; Five Firms; IPA; Katten Muchin; Munck Carter; NYCBA; REISA; Rutledge; Seward & Kissel; SIFMA; S&C; Whitaker Chalk.

226

See

comment letters from ABA Fed. Reg. Comm.; Coy Capital; Five Firms; MFA; NYCBA; S&C.

227

See

comment letters from ABA Fed. Reg. Comm.; Coy Capital; Five Firms.

228

See

comment letters from Five Firms; MFA.

229

See

comment letters from ABA Fed. Reg. Comm.; Coy Capital; IPA; Lehman & Eilen; MFA; Munck Carter; REISA; Rutledge; SIFMA; Whitaker Chalk.

230

See

comment letters from ABA Fed. Reg. Comm.; Cleary Gottlieb; Five Firms; Rutledge; S&C.

231

See

comment letter from ABA Fed. Reg. Comm.

In light of the views expressed by commenters, including concerns about potential unfairness, we have determined not to trigger Rule 506 disqualification on the basis of preexisting events. Accordingly, the amendments we are adopting today include a provision specifying that disqualification will not arise as a result of triggering events that occurred before the effective date of the rule amendments.

232

We will, however, require disclosure to investors regarding such events.

232

See

Rule 506(d)(2)(i). The rule looks to the timing of the triggering event (

e.g.,

a criminal conviction or court or regulatory order) and not the timing of the underlying conduct. A triggering event that occurs after effectiveness of the rule amendments will result in disqualification, even if the underlying conduct occurred before effectiveness.

2. Mandatory Disclosure of Triggering Events That Pre-Date Effectiveness of the Rule Amendments

In the proposing release, we solicited comment on whether we should require disclosure, rather than disqualification, for bad actor triggering events that occurred before the effective date o

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