Disqualification of Bad Actors, Felons SEC’s New Agenda

Jack Humphrey, Regulatory journalist
May 27, 2011 /

The Securities and Exchange Commission (SEC) wants “felons and other bad actors” to be denied the exemption from registering with the SEC when offering securities.

A new SEC proposal would implement provisions in the Dodd-Frank Act, particularly section 926 that requires the commission to adopt rules that would deny this exemption to any securities offering in which certain “felons and other bad actors” are involved.

Regulation D exempts an individual or a company from registering with the SEC when seeking to offer or sell a security such as a stock or bond. It provides three exemptions, the most widely used of which is Rule 506 in which an issuer can raise unlimited capital from an unlimited number of accredited investors and up to 35 non-accredited investors.

The SEC’s proposal will disqualify from Rule 506 exemption an issuer that has a “disqualifying event” such as a criminal conviction, court injunction and restraining order.

The disqualification covers the issuer, including its predecessors and affiliated issuers, as well as directors, officers, general partners and managing members of the issuer; 10 percent beneficial owners and promoters of the issuer; and persons compensated for soliciting investors, as well as the general partners, directors, officers and managing members of any compensated solicitor.

They can be disqualified in the event of criminal convictions related to the purchase or sale of a security, false filing with the SEC or conducting certain types of financial intermediaries, the SEC said.

The criminal conviction must have occurred within 10 years of the proposed sale of securities, or five years in the case of the issuer and its predecessors and affiliated issuers.

Other “disqualifying events” include final orders from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration barring the issuer from associating with a regulated entity, engaging in the business of securities, insurance or banking, and engaging in savings association or credit union activities.

An issuer can also be disqualified if there are effective SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons.

If an issuer has been suspended or expelled from any “self-regulatory organization” or from association with an SRO member, the disqualification applies.

In the even of an SEC stop orders and orders suspending the Regulation A exemption and U.S. Postal Service false representation orders issued within five years before the proposed sale of securities, an issuer could likewise be disqualified from offering securities.

However, the proposal exempts an issuer from disqualification when it can show it did not have any knowledge of the disqualification.

The SEC seeks public comments on the proposal until July 14, 2011 before preparing the final rules to be adopted by Section 926 of the Dodd-Frank Act.

 

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