Bad actor disqualification is a Regulation D rule (Rule 506(d)) that prevents a fund from using the Rule 506 exemption if certain "covered persons" associated with the fund have specified legal or disciplinary history. Disqualifying events include securities-related criminal convictions, SEC disciplinary orders, and FINRA suspensions.
Why It Matters
If a covered person associated with your fund has a disqualifying event, the fund cannot rely on Rule 506 to raise capital. This can shut down a fundraise entirely. Fund managers must screen all covered persons before launching an offering and monitor for new disqualifying events on an ongoing basis.
Key Details
- Covered persons include the issuer, its directors, officers, general partners, managing members, 20%+ equity owners, and compensated solicitors (including their directors, officers, and general partners).
- Disqualifying events include felony or misdemeanor convictions in connection with securities, with a 10-year lookback for issuers and a 5-year lookback for individuals.
- SEC cease-and-desist orders and state securities regulator orders also qualify as disqualifying events.
- Events that occurred before September 23, 2013 (the rule's effective date) require disclosure to investors but are not disqualifying.
- The fund manager bears the burden of conducting reasonable inquiry into the background of all covered persons.
For more, see Bad Actor Disqualification: What Fund Managers Need to Know.
Capital Company includes covered person screening support as part of fund administration.
This content is for informational purposes only and does not constitute legal, tax, or compliance advice. Consult qualified counsel for guidance specific to your situation.