Bad Actor Disqualification Under Regulation D

Regulation D Rule 506(d) disqualifies a fund from using the 506(b) or 506(c) exemption if certain "covered persons" associated with the fund have specified legal or disciplinary history. A single disqualifying event among your GPs, directors, officers, 20%+ equity holders, or promoters can block your entire offering. This screen must be completed before your first sale of securities.

Who Are "Covered Persons"

The covered persons list is broader than most fund managers expect. It extends well beyond the fund's principals to include anyone in a position to influence the offering or benefit from it.

• The issuer itself (your fund entity, including the GP entity)
• Directors, executive officers, general partners, or managing members of the issuer
• Any person who owns 20% or more of the issuer's outstanding equity
• Promoters connected with the issuer at the time of sale
• Persons compensated for soliciting investors (placement agents, finders, and their firms)
• Directors, executive officers, and general partners of any compensated solicitor

What Triggers Disqualification

The following events, when attributable to a covered person, disqualify your fund from using Rule 506:

• Criminal convictions in connection with the purchase or sale of securities, involving false filings with the SEC, or arising from the conduct of certain financial intermediaries. The lookback period is 10 years for the issuer entity and 5 years for individual covered persons, measured from the date of conviction.
• Court injunctions or restraining orders in connection with the purchase or sale of securities, involving false filings, or related to the conduct of certain financial intermediaries. The lookback is 5 years from the date of the order.
• SEC disciplinary orders under Sections 15(b) or 15B(c) of the Exchange Act, Section 203(e) or 203(f) of the Advisers Act, or that bar or suspend the person from association with a regulated entity.
• SEC cease-and-desist orders related to scienter-based anti-fraud provisions or Section 5 of the Securities Act (registration requirements).
• CFTC orders involving fraud, manipulation, or similar misconduct.
• Suspension or expulsion from membership in, or association with a member of, a self-regulatory organization (FINRA, national securities exchanges).
• SEC stop orders relating to a Regulation A filing, or SEC orders suspending the Regulation A exemption, within the past 5 years.
• U.S. Postal Service false representation orders within the past 5 years.

The Reasonable Care Defense

Rule 506(d)(2)(ii) provides an affirmative defense. If you did not know and, in the exercise of reasonable care, could not have known that a covered person had a disqualifying event, the disqualification does not apply.

This defense requires more than good intentions. You must actually conduct the screening. If you never check FINRA BrokerCheck, never run background checks, and never ask your covered persons about their regulatory history, "we did not know" is not a defense. The SEC will ask what steps you took.

Document your screening process. Maintain records showing which databases you searched, when you searched them, and what certifications you obtained from covered persons. If your screening was thorough and still missed something that was genuinely not discoverable, the defense protects you.

Pre-Existing Events (Before September 23, 2013)

Rule 506(d) took effect on September 23, 2013. Disqualifying events that occurred before that date do not automatically disqualify your offering. However, they trigger a mandatory disclosure obligation.

You must disclose pre-existing events to investors in writing a reasonable time before the sale. The disclosure should describe the event, identify the covered person, and explain why it does not trigger disqualification (because it predates the rule's effective date).

How to Screen

A thorough bad actor screen involves multiple sources. No single database captures every category of disqualifying event.

• FINRA BrokerCheck (brokercheck.finra.org): Covers registration history, regulatory actions, and arbitration events for broker-dealers and their associated persons. Free and publicly accessible.
• SEC EDGAR (sec.gov/cgi-bin/browse-edgar): Search for administrative proceedings, litigation releases, and enforcement actions involving covered persons.
• SEC Investment Adviser Public Disclosure (adviserinfo.sec.gov): Covers disciplinary history for registered investment advisers and their associated persons.
• State securities regulator databases: Each state maintains records of enforcement actions. Check the states where covered persons are based or have operated.
• Criminal background checks: Run through a reputable third-party provider covering federal and state courts. The 506(d) lookback is 5 years for individuals and 10 years for entities.
• Written certifications: Require each covered person to complete a questionnaire certifying that they are not subject to any disqualifying events. This is your first line of defense and the basis for your reasonable care argument.

Complete your screening before the first sale of securities in the offering. For ongoing or evergreen offerings, re-screen periodically and whenever a new covered person joins (new GP member, new 20% owner, new placement agent).

What to Do If a Disqualifying Event Exists

Discovering a disqualifying event does not mean your fund cannot raise capital. But it does mean you have work to do.

• Pre-existing events (before September 23, 2013): Disclose to investors in writing. No waiver needed.
• Post-2013 events: You will need an SEC waiver under Rule 506(d)(2)(i) or a court/regulatory authority determination that the disqualification should not apply. The waiver process involves filing a request with the SEC and demonstrating why the disqualification is not warranted.
• Restructure covered person relationships: If the covered person with the disqualifying event can resign as an officer, reduce equity below 20%, or otherwise remove themselves from covered person status, the disqualification may no longer apply. Consult counsel before taking this path.
• Change placement agents: If the disqualifying event sits with your placement agent or one of their executives, switching to a clean placement agent removes the problem.

Common Mistakes

• Not screening placement agents and their executives. Fund managers routinely screen their own team but forget that the placement agent's directors and officers are also covered persons. A disqualifying event at the placement firm blocks your offering just as effectively as one at the GP.
• Not updating screening when new covered persons join. Adding a new managing member, bringing on a 20%+ equity investor, or hiring a new placement agent mid-offering each adds new covered persons who must be screened before the next sale.
• Assuming minor infractions do not count. A misdemeanor securities conviction within the lookback period triggers disqualification. There is no de minimis exception. The question is whether the event falls within a listed category, not whether it was serious.
• Skipping the screen entirely. Some fund managers assume bad actor screening is only for large institutions or heavily regulated offerings. Rule 506(d) applies to every 506(b) and 506(c) offering, regardless of fund size.

For more on Regulation D exemptions, see our guide to 506(b) vs 506(c). For a broader view of available fund exemptions, read private fund exemptions.

This guide is for informational purposes only and does not constitute legal, tax, or investment advice. Rule 506(d) disqualification provisions are subject to SEC interpretation and rulemaking. Consult qualified legal counsel before making compliance decisions for your fund.