
[Federal Register Volume 78, Number 142 (Wednesday, July 24, 2013)]
[Rules and Regulations]
[Pages 44729-44771]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-16983]



[[Page 44729]]

Vol. 78

Wednesday,

No. 142

July 24, 2013

Part IV





Securities and Exchange Commission





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17 CFR Parts 200, 230, 239, et al.





Disqualification of Felons and Other ``Bad Actors'' from Rule 506 
Offerings; Eliminating the Prohibition Against General Solicitation and 
General Advertising in Rule 506 and Rule 144A Offerings; Amendments to 
Regulation D, Form D and Rule 156; Final Rules and Proposed Rule

  Federal Register / Vol. 78 , No. 142 / Wednesday, July 24, 2013 / 
Rules and Regulations  

[[Page 44730]]


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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.

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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,\1\ 
147,\2\ 152 \3\ and 155; \4\ Rules 501 \5\ and 506 \6\ of Regulation 
D;\7\ and Form D \8\ under the Securities Act of 1933 \9\ and to Rule 
30-1 \10\ of our Rules of Organization and Program Management.
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    \1\ 17 CFR 230.145.
    \2\ 17 CFR 230.147.
    \3\ 17 CFR 230.152.
    \4\ 17 CFR 230.155.
    \5\ 17 CFR 230.501.
    \6\ 17 CFR 230.506.
    \7\ 17 CFR 230.500 through 230.508.
    \8\ 17 CFR 239.500.
    \9\ 15 U.S.C. 77a et seq.
    \10\ 17 CFR 200.30-1.
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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.\11\ The Commission 
proposed rule amendments to implement Section 926 of the Dodd-Frank Act 
on May 25, 2011.\12\ 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,\13\ are generally consistent with the proposal, but will apply 
only to triggering events occurring after effectiveness of the rule 
amendments (with pre-existing events

[[Page 44731]]

subject to mandatory disclosure) and also reflect some changes in 
response to comments.
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    \11\ Public Law 111-203, sec. 926, 124 Stat. 1376, 1851 (July 
21, 2010) (codified at 15 U.S.C. 77d note).
    \12\ 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)].
    \13\ 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).
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    Rule 506 is one of three exemptive rules for limited offerings 
under Regulation D.\14\ It is by far the most widely used Regulation D 
exemption, accounting for an estimated 90% to 95% of all Regulation D 
offerings \15\ and the overwhelming majority of capital raised in 
transactions under Regulation D.\16\ 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.
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    \14\ 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.
    \15\ 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.
    \16\ 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.
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    Rule 506 historically has permitted sales to an unlimited number of 
accredited investors \17\ 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.\18\ 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.\19\ 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).\20\ 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.
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    \17\ 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.
    \18\ 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.
    \19\ See Public Law 112-106, sec. 201(a), 126 Stat. 306, 313 
(Apr. 5, 2012).
    \20\ Eliminating the Prohibition Against General Solicitation 
and General Advertising in Rule 506 and Rule 144A Offerings, Release 
No. 33-9415 (July 10, 2013).
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    ``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.\21\ 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.\22\
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    \21\ 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).
    \22\ 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.
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    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,\23\ 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:
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    \23\ 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.
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     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

[[Page 44732]]

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:
    [cir] being subject to a Commission order:
    [ssquf] revoking or suspending their registration as a broker, 
dealer, municipal securities dealer, or investment adviser;
    [ssquf] placing limitations on their activities as such;
    [ssquf] barring them from association with any entity; or
    [ssquf] barring them from participating in an offering of penny 
stock; or
    [cir] 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
    [cir] 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
    [cir] 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.\24\ We received 44 
comment letters in response to our proposal.\25\ In addition, we 
received three advance comment letters commenting on Section 926 before 
the publication of the proposing release.\26\ 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.
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    \24\ 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)].
    \25\ 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.
    \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.''
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    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.\27\ The 
amendments we are adopting are generally consistent with the proposal, 
with the following principal differences:
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    \27\ 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).
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     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.\28\ 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.\29\
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    \28\ 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).
    \29\ 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'').
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    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.\30\ We 
are

[[Page 44733]]

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.
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    \30\ 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.
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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,\31\ general partner or managing 
member of the issuer;
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    \31\ 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.
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     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.\32\
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    \32\ 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.\33\ 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.
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    \33\ 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).
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    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 \34\ 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.
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    \34\ 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.
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    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; \35\ 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; \36\ 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; \37\ the potentially heavy 
compliance burden associated with broad application, which may make it 
difficult for issuers to meet a ``reasonable care'' standard; \38\ and 
the obligation it would create for compensated solicitors to disclose 
the identities of their employees to issuers.\39\ 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 
\40\ or that are responsible for the approval or supervision of Rule 
506 offerings.\41\
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    \35\ See comment letters from DTC; NYCBA; Sullivan & Cromwell 
LLP (July 14, 2011) (``S&C'').
    \36\ See comment letter from ABA Fed. Reg. Comm.
    \37\ 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'').
    \38\ 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).
    \39\ See comment letter from Cleary Gottlieb.
    \40\ See comment letters from ABA Fed. Reg. Comm.; NYCBA.
    \41\ See comment letter from Lehman & Eilen.
---------------------------------------------------------------------------

    Two commenters advocated that the new rules mirror Rule 262's 
coverage of ``officers,'' as proposed.\42\ 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.
---------------------------------------------------------------------------

    \42\ 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 \43\ and that doing so may be preferable 
to covering all officers.\44\ Both commenters, however, expressed 
concern about the potential difficulty of determining which officers 
were

[[Page 44734]]

actually involved with or participating in an offering.\45\
---------------------------------------------------------------------------

    \43\ See comment letter from Cleary Gottlieb.
    \44\ See comment letter from S&C.
    \45\ 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 \46\ 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.\47\ 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.
---------------------------------------------------------------------------

    \46\ 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.
    \47\ 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.\48\ 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,\49\ with 10% holders potentially a ``moving target'' for 
issuers engaged in continuous sales and regular redemptions.\50\ 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.\51\ One commenter questioned whether public companies would 
be able to comply with the rule.\52\ Two commenters urged the 
Commission not to include beneficial owners as covered persons at all 
in the new disqualification rule.\53\ Some commenters suggested higher 
ownership thresholds, from 20% to majority ownership \54\ or a test 
based on actual control,\55\ while others argued against an actual 
control test and in favor of a bright-line standard based on a stated 
percentage of ownership.\56\
---------------------------------------------------------------------------

    \48\ 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'').
    \49\ See comment letter from Seward & Kissel.
    \50\ See comment letters from ABA Fed. Reg. Comm.; IPA.
    \51\ See comment letter from Lehman & Eilen; see also comment 
letters from ABA Fed. Reg. Comm.; Five Firms; S&C.
    \52\ See comment letter from ABA Fed. Reg. Comm. (pointing out 
that 10% beneficial owners have no obligation to disclose whether 
they are bad actors).
    \53\ See comment letters from ABA Fed. Reg. Comm.; Seward & 
Kissel.
    \54\ 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).
    \55\ 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).
    \56\ 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.\57\ 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,\58\ 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.\59\ Another suggested that the 
provision be limited to voting securities, including general partner 
and managing member interests, and exclude passive interests.\60\
---------------------------------------------------------------------------

    \57\ 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.
    \58\ 15 U.S.C. 80a-2(a)(42).
    \59\ See comment letter from ABA Fed. Reg. Comm.
    \60\ 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.\61\
---------------------------------------------------------------------------

    \61\ 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

[[Page 44735]]

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.\62\ 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.
---------------------------------------------------------------------------

    \62\ 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.\63\
---------------------------------------------------------------------------

    \63\ 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 
\64\ 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.
---------------------------------------------------------------------------

    \64\ 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 \65\ 
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.\66\ 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,\67\ while six opposed 
it on a variety of bases, including that investment advisers are 
already subject to fiduciary duties and an extensive regulatory regime; 
\68\ 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

[[Page 44736]]

the fund's general partner; \69\ and that extending the rule in this 
way would be premature, would require a separate rulemaking project or 
would violate the ``substantially similar'' requirement.\70\ 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.\71\ 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.\72\
---------------------------------------------------------------------------

    \65\ 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.
    \66\ 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.
    \67\ See comment letters from Better Markets; DTC; NASAA.
    \68\ See comment letters from ABA Fed. Reg. Comm.; SIFMA; 
Whitaker Chalk.
    \69\ See comment letter from Katten Muchin;
    \70\ See comment letters from Lehman & Eilen; Rutledge.
    \71\ 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].
    \72\ 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,\73\ 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,\74\ 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.\75\ 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.\76\
---------------------------------------------------------------------------

    \73\ 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).
    \74\ 15 U.S.C. 77c(b)(1).
    \75\ 17 CFR 230.602(c).
    \76\ 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 \77\ 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.\78\ 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.\79\ 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).\80\ 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.\81\
---------------------------------------------------------------------------

    \77\ 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.
    \78\ See comment letters from Cleary Gottlieb; SIFMA; S&C.
    \79\ See comment letter from Cleary Gottlieb.
    \80\ See comment letter from S&C.
    \81\ 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.\82\ In particular, the 
definition requires issuers to look through entities and makes it

[[Page 44737]]

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.
---------------------------------------------------------------------------

    \82\ 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.\83\
---------------------------------------------------------------------------

    \83\ 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.\84\ 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,\85\ and we are adopting it as proposed.
---------------------------------------------------------------------------

    \84\ See Rule 506(d)(3).
    \85\ 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.\86\ Another commenter argued that disqualification should 
cease to apply following changes of policy, as well as changes of 
control.\87\ 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.\88\ 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.
---------------------------------------------------------------------------

    \86\ 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).
    \87\ 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).
    \88\ See comment letters from DTC; NYCBA; Rutledge.
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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; \89\
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    \89\ See Proposed Rule 506(c)(1)(i).
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     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; \90\
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    \90\ 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

[[Page 44738]]

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;\91\
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    \91\ See Proposed Rule 506(c)(1)(iii).
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     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; \92\
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    \92\ See Proposed Rule 506(c)(1)(iv).
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     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; \93\
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    \93\ 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; \94\ and
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    \94\ 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.\95\
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    \95\ 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.\96\
---------------------------------------------------------------------------

    \96\ 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.\97\ 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.
---------------------------------------------------------------------------

    \97\ 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.\98\ One commenter 
criticized the proposal as overbroad and suggested ways to narrow 
it,\99\ 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\
---------------------------------------------------------------------------

    \98\ See comment letters from Rutledge; Five Firms; S&C Seward 
& Kissel; SIFMA; NYCBA.
    \99\ 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.
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    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

[[Page 44739]]

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\
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    \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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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

[[Page 44740]]

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.
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    \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\
---------------------------------------------------------------------------

    \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

[[Page 44741]]

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 Sec.  
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

[[Page 44742]]

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 
Sec.  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\
---------------------------------------------------------------------------

    \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

[[Page 44743]]

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 v. 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\
---------------------------------------------------------------------------

    \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

[[Page 44744]]

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

[[Page 44745]]

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 v. North American Research and Development Corp., 
424 F.2d 63, 8182 (2d Cir. 1970); Swenson, 626 F.2d at 424 (5th); 
SEC v. Ross, 504 F.3d 1130, 1137 (9th Cir. 2007); SEC v. 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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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

[[Page 44746]]

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\
---------------------------------------------------------------------------

    \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,

[[Page 44747]]

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\
---------------------------------------------------------------------------

    \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

[[Page 44748]]

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, Sec.  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

[[Page 44749]]

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 v. 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 of the new 
rules. Several commenters were supportive.\233\ One commenter viewed 
the disclosure requirement favorably as a way to balance fairness to 
issuers and other covered persons with the need for investor protection 
without impairing the effectiveness of the rule.\234\ This commenter 
noted that any negative impact associated with applying 
disqualification only to events occurring after the effective date of 
the rule amendments would be ameliorated by requiring disclosure to 
investors of the existence of the event. Another commenter viewed 
disclosure as an appropriate method of dealing with past orders or 
convictions rather than imposing automatic disqualification since 
issuers would be unable to revisit the disqualifying conduct and alter 
the collateral consequences of those past convictions and orders as a 
result of the new disqualifying provisions.\235\ In addition, one 
commenter argued more generally that the disqualification rules should 
be broadly reconsidered and a disclosure-based approach adopted 
instead.\236\
---------------------------------------------------------------------------

    \233\ See comment letters from Lehman & Eilen; Munck Carter; 
REISA.
    \234\ See comment letter from Munck Carter.
    \235\ See comment letter from REISA.
    \236\ See comment letter from ABA Fed. Reg. Comm.
---------------------------------------------------------------------------

    In lieu of imposing disqualification for pre-existing triggering 
events, the rule amendments require written disclosure of matters that 
would have triggered disqualification, except that they occurred before 
the effective date of the new disqualification provisions.\237\ In 
light of Congress' concerns about the participation of certain felons 
and other bad actors in Rule 506 offerings, we believe this disclosure 
is important to put investors on notice of bad actor involvement in 
Rule 506 offerings that they are evaluating as potential investments. 
We believe this is particularly important after adoption of the new bad 
actor disqualification requirements for Rule 506 offerings because, as 
a result of the adoption of the new requirements implementing Section 
926, investors may have the impression that all bad actors are now 
disqualified from participation in Rule 506 offerings. We expect that 
issuers will give reasonable prominence to the disclosure to ensure 
that information about pre-existing bad actor events is appropriately 
presented in the total mix of information available to investors.
---------------------------------------------------------------------------

    \237\ See Rule 506(e).
---------------------------------------------------------------------------

    The disclosure requirement in new Rule 506(e) will apply to all 
offerings under Rule 506, regardless of whether purchasers are 
accredited investors. Issuers will be required to provide disclosure 
``a reasonable time prior to sale,'' which is the same timing that 
currently applies to disclosures to non-accredited investors under Rule 
502(b)(1).\238\
---------------------------------------------------------------------------

    \238\ 17 CFR 230.502(b)(1).
---------------------------------------------------------------------------

    If disclosure is required and not adequately provided to an 
investor, we do not believe that relief will be available under Rule 
508, under which ``insignificant deviations'' from Regulation D 
requirements do not necessarily result in loss of the Securities Act 
exemption with regard to an offer or sale of securities to a particular 
individual or entity.\239\ For Rule 508 to apply to an offer or sale of 
securities, the failure to comply with a Regulation D requirement must 
not pertain to a term, condition or requirement directly intended to 
protect that offeree or purchaser.\240\ Disclosure of pre-existing 
triggering events under

[[Page 44750]]

new Rule 506(e) is intended to benefit all investors by alerting them 
to any bad actors associated with the issuer or the offering, and, 
therefore, this condition of Rule 508 cannot be met where the required 
disclosure is not provided.
---------------------------------------------------------------------------

    \239\ See note 190.
    \240\ See 17 CFR 230.508(a)(1).
---------------------------------------------------------------------------

    Rule 506(e) does, however, provide that the failure to furnish 
required disclosure on a timely basis will not prevent an issuer from 
relying on Rule 506 if the issuer establishes that it did not know, and 
in the exercise of reasonable care could not have known, of the 
existence of the undisclosed matter or matters. This ``reasonable 
care'' exception to the disclosure requirement is similar to the 
``reasonable care'' exception to disqualification we are also adopting 
today, and will preserve an issuer's claim to reliance on Rule 506 if 
disclosure is required but the issuer can establish that it did not 
know and in the exercise of reasonable care could not have known of the 
matters required to be disclosed. The provision also includes an 
instruction, similar to the instruction to Rule 506(d)(2)(iv), 
clarifying that reasonable care requires factual inquiry.
3. Timing of Implementation
    Under our proposal, the new bad actor disqualification rules would 
have been implemented without any deferral period. We solicited comment 
on whether deferral would be appropriate. While two commenters opposed 
any delayed implementation, citing investor protection concerns,\241\ 
several others urged us to implement the rules on a delayed basis to 
permit issuers to put compliance procedures in place and allow time for 
obtaining any necessary waivers.\242\
---------------------------------------------------------------------------

    \241\ See comment letters from DTC; NASAA.
    \242\ See, e.g., comment letters from ABA Fed. Reg. Comm.; Five 
Firms; Kutak Rock; NYCBA; SIFMA.
---------------------------------------------------------------------------

    As adopted, the bad actor disqualification provisions of Rule 
506(d) will take effect 60 days after publication in the Federal 
Register, without any additional deferral period. We concluded that an 
additional deferral is not necessary or appropriate since 
disqualification will not be imposed in respect of pre-existing 
triggering events so, although issuers and other offering participants 
will need to make reasonable factual inquiries during this 60-day 
period, no additional time is needed for waivers to be sought in 
respect of such events. Accordingly, the new disqualification 
provisions of Rule 506(d) and the mandatory disclosure provision of 
Rule 506(e) will apply to each sale of securities made in reliance on 
Rule 506 after the rule amendments go into effect.
    As we discussed in the proposing release, sales of securities made 
before the applicable effective dates will not be affected by any 
disqualification or disclosure requirement, even if such sales are part 
of an offering that continues after the relevant effective date. Only 
sales made after the effective date of the amendments will be subject 
to disqualification and mandatory disclosure.
    Disqualifying events that occur while an offering is underway will 
be treated in a similar fashion. Sales made before the occurrence of 
the disqualification trigger will not be affected by it, but sales made 
afterward will not be entitled to rely on Rule 506 unless the 
disqualification is waived or removed, or, if the issuer is not aware 
of a triggering event, the issuer can rely on the reasonable care 
exception.\243\
---------------------------------------------------------------------------

    \243\ Disqualifying events that exist at the time the offering 
is commenced but are only discovered later will be disqualifying, 
and the sales will not be eligible for reliance on Rule 506, subject 
to the application of the reasonable care exception.
---------------------------------------------------------------------------

    This approach is consistent with our other rules and we believe 
provides appropriate incentives to issuers and other covered persons. 
We solicited comment on other possible approaches, including not 
applying the new rules to offerings that are underway at the time of 
effectiveness of the new disqualification provisions. Several 
commenters supported complete or partial grandfathering for offerings 
that are underway at the time of effectiveness.\244\ We do not think 
such grandfathering would be necessary, given that pre-existing events 
will give rise only to a disclosure requirement and not to 
disqualification. Further, some ongoing offerings could continue for 
years after the rule amendments take effect. We do not believe it would 
be appropriate to implement Section 926 in a way that would exempt such 
offerings on a long-term basis. Issuers should be able to make 
reasonable factual inquiries and prepare any necessary disclosures 
during the 60 days before the rules become effective.
---------------------------------------------------------------------------

    \244\ See comment letters from Katten Muchin; Whitaker Chalk; 
Coy Capital; Rutledge.
---------------------------------------------------------------------------

G. Amendment to Form D

    We are adopting as proposed the conforming amendment to Form D. 
Under the amendment, the signature block of the Form D will contain a 
certification, similar to the current certification by Rule 505 
issuers, whereby issuers claiming a Rule 506 exemption will confirm 
that the offering is not disqualified from reliance on Rule 506 for one 
of the reasons stated in Rule 506(d).

III. Paperwork Reduction Act

A. Background

    The mandatory disclosure provisions required under the final rules 
contain ``collection of information'' requirements within the meaning 
of the Paperwork Reduction Act of 1995 (``PRA'').\245\ The title for 
the collection of information is:
---------------------------------------------------------------------------

    \245\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

     ``Regulation D Rule 506(e) Felons and Other Bad Actors 
Disclosure Statement.'' We are requesting comment on the collection of 
information requirements in this adopting release, and are submitting 
these requirements to the Office of Management and Budget (``OMB'') for 
review in accordance with the PRA and its implementing 
regulations.\246\ We are applying for an OMB control number for the 
proposed new collection of information in accordance with 44 U.S.C. 
3507(j) and 5 CFR 1320.13, and OMB has not yet assigned a control 
number to the new collection. Responses to the new collection of 
information would be mandatory. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------

    \246\ In the proposing release, we did not submit a PRA analysis 
because we did not propose mandatory disclosure of past 
disqualifying events. At this time, we do not have any comments 
regarding overall burden estimates for the rule amendments. This 
release is requesting such comments.
---------------------------------------------------------------------------

    As adopted, the amendments to Rule 506 require that the issuer 
furnish to each purchaser, a reasonable time prior to sale, a written 
description of any matters that occurred before effectiveness of the 
final amendments and within the time periods described in the list of 
disqualification events set forth in Rule 506(d)(1) of Regulation D, in 
regard to the issuer or any other ``covered person'' associated with 
the offering. For purposes of the mandatory disclosure provision of 
Rule 506(e), issuers will be required to ascertain whether any 
disclosures are required in respect of covered persons involved in 
their offerings, prepare any required disclosures and furnish them to 
purchasers.
    The Commission adopted the Regulation D Rule 506(e) Felons and 
Other Bad Actors Disclosure Statement under the Securities Act. The 
Regulation D Rule 506(e) Felons and Other Bad Actors Disclosure 
Statement required to be furnished to investors does not involve 
submission of a form

[[Page 44751]]

filed with the Commission and is not required to be presented in any 
particular format, although it must be in writing. The hours and costs 
associated with preparing and furnishing the Regulation D Rule 506(e) 
Felons and Other Bad Actors Disclosure Statement to investors in the 
offering constitute reporting and cost burdens imposed by the 
collection of information. An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid OMB control number.
    The disclosure or paperwork burden imposed on issuers appears in 
Rule 506(e) and pertains to events that occurred before effectiveness 
of the final rules but which would have triggered disqualification had 
they occurred after effectiveness. Issuers relying on Rule 506 must 
furnish disclosure of any relevant past events listed in Rule 506(e) 
that relate to the issuer or any other covered person. If there are any 
such events, a disclosure statement is required to be furnished, a 
reasonable time before sale, to all purchasers in the offering. The 
disclosure requirement serves to protect purchasers by ensuring that 
they receive information regarding any covered persons that were 
subject to such disqualifying events.
    The disclosure requirement does not apply to triggering events 
occurring after the effective date of the rule amendments adopted 
today, because those events will result in disqualification from 
reliance on Rule 506 (absent a waiver or other exception provided in 
Rule 506(d)), rather than any disclosure obligation.
    The steps that issuers will take to comply with the disclosure 
requirement are expected to mirror the steps they take to determine 
whether they are disqualified from relying on Rule 506. We expect that 
issuers planning or conducting a Rule 506 offering will undertake a 
factual inquiry to determine whether they are subject to any 
disqualification. Disqualification and mandatory disclosure are 
triggered by the same types of events in respect of the same covered 
persons, with disqualification arising from triggering events occurring 
after these rules take effect and mandatory disclosure applicable to 
events occurring before that date. Therefore, we expect that factual 
inquiry into potential disqualification can simply be extended to cover 
the period before the rules become effective. On that basis, we expect 
that the factual inquiry process for the disclosure statement 
requirement will impose a limited incremental burden on issuers.
    As stated earlier, we expect that the size of the issuer and the 
circumstances of the particular Rule 506 offering will determine the 
scope of the factual inquiry and require tailored and offering-specific 
data gathering approaches. It should not generally be necessary for any 
issuer or any compensated solicitor to make inquiry of any covered 
individual with respect to ascertaining the existence of events that 
require disclosure more than once, because the period to be covered by 
the inquiry ends with the effective date of the new disqualification 
rules (so future events are unlikely to affect the inquiry or change 
the disclosures that have to be made). We do, however, expect that 
issuers may be required to revise their factual inquiry for each Rule 
506 offering due to changes in management or intermediaries, other 
changes to the group of covered persons or if questions arise about the 
accuracy of previous responses. We also expect that the disclosure 
requirement may serve the additional function of helping issuers 
develop processes and procedures for the factual inquiry required to 
establish reasonable care under the disqualification provisions of Rule 
506(d), which will be effective prospectively.

B. Burden and Cost Estimates Related to the Adopted Amendments

    We anticipate that the disclosure requirement will result in an 
incremental increase in the burdens and costs for issuers that rely on 
the Rule 506 exemption by requiring these issuers to conduct factual 
inquiries into the backgrounds of covered persons with regard to events 
that occurred before effectiveness of the final bad actor 
disqualification rules. For purposes of the PRA, we estimate the total 
annual increase in paperwork burden for all affected Rule 506 issuers 
to comply with our proposed collection of information requirements to 
be approximately 22,108 hours of company personnel time and 
approximately $264,000 for the services of outside professionals. These 
estimates include the incremental time and cost of conducting a factual 
inquiry to determine whether the Rule 506 issuers have any covered 
persons with past disqualifying events. The estimates also include the 
cost of preparing a disclosure statement that issuers are required to 
furnish to each purchaser a reasonable time prior to sale.\247\
---------------------------------------------------------------------------

    \247\ 17 CFR 230.502(b)(2)(iii).
---------------------------------------------------------------------------

    In deriving our estimates, we assume that:
     Approximately 19,908 Rule 506 issuers \248\ relying on 
Rule 506 of Regulation D will spend on average one additional hour to 
conduct a factual inquiry to determine whether any covered persons had 
a disqualifying event that occurred before the effective date of the 
rule amendments; and
---------------------------------------------------------------------------

    \248\ Filing data reviewed by the staff of the Commission's 
Division of Economic and Risk Analysis indicate that for 2012, 
15,028 issuers claiming the Rule 506 exemption filed one Form D and 
1,250 such issuers filed more than one Form D. For purposes of the 
PRA estimates, we assume that all initial filers and approximately 
one quarter of repeat filers will conduct a factual inquiry, with 
the remaining repeat filers relying on prior factual inquiries. 
There is evidence that some issuers are not filing Form D for their 
offerings in compliance with Rule 503 as discussed in Part IX.B.4.a. 
of Amendments to Regulation D, Form D and Rule 156 under the 
Securities Act, Proposing Release No. 33-9416, (July 10, 2013). In 
addition, we estimate that the amendments to Rule 506(c) adopted 
today will result in a 20% increase in Form D filings relying on the 
Rule 506(c) exemption. See Eliminating the Prohibition Against 
General Solicitation and General Advertising in Rule 506 and Rule 
144A Offerings, Adopting Release No. 33-9415, Part V.B. (July 10, 
2013). For purposes of our PRA estimates, we have assumed that the 
estimated 20% increase in the number of Form D filings corresponds 
to a 20% increase in the number of issuers that will need to conduct 
a factual inquiry to determine whether a disclosure statement is 
necessary.
---------------------------------------------------------------------------

     On the basis of the factual inquiry, approximately 220 
\249\ Rule 506 issuers will spend ten hours to prepare a disclosure 
statement describing matters that would have triggered disqualification 
under Rule 506(d)(1) of Regulation D had they occurred on or after the 
effective date of the rule amendments; and
---------------------------------------------------------------------------

    \249\ Staff estimates that there were at least 549 SEC 
enforcement cases involving an unregistered offering in which 
someone who would be disqualified as a bad actor participated in the 
five years from 2007 through 2011, see Part IV.B.3, or at least 110 
such offerings per year. This is a lower bound estimate based on a 
review of triggering events arising from Commission action only, and 
not other triggering events such as criminal convictions and state 
regulatory action. For purposes of the Paperwork Reduction Act 
analysis, we are doubling the number of Rule 506 offerings estimated 
to involve a bad actor, to account for such other triggering events. 
We are not aware of any database that would allow us to estimate 
with precision the number of other triggering events or the number 
of additional bad actors associated with them. Some data on state 
enforcement actions indicate that there would be a substantial 
number of other triggering events (see, e.g., NASAA's 2012 
Enforcement Report, discussed at text accompanying note 283); 
however, the data do not allow us to determine how many state 
enforcement actions are unique, as more than one state may take 
regulatory action against the same person and some state actions may 
overlap with Commission actions.
---------------------------------------------------------------------------

     For purposes of the disclosure statement, 220 Rule 506 
issuers will retain outside professional firms to spend three hours on 
disclosure preparation at an average cost of $400 per hour.

The increase in burdens and costs associated with conducting the 
factual

[[Page 44752]]

inquiry for the disclosure statement requirement should pose a minimal 
incremental effort given that issuers are simultaneously required to 
conduct a similar factual inquiry for purposes of determining 
disqualification from the Rule 506 exemption.
    It is difficult to provide any standardized estimates of the costs 
involved with the factual inquiry. There is no central repository that 
aggregates information from all federal and state courts and regulators 
that would be relevant in determining whether a covered person has a 
disqualifying event in his or her past. In this regard, we are 
currently unable to accurately estimate the burdens and costs for 
issuers in a verifiable way. We expect, however, that the costs to 
issuers may be higher or lower depending on the size of the issuer and 
the number and roles of covered persons. We realize there may be a wide 
range of issuer size, management structure, and offering participants 
involved in Rule 506 offerings and that different issuers may develop a 
variety of different factual inquiry procedures.
    Where the issuer or any covered person is subject to an event 
listed in Rule 506(e) existing before the effective date of these 
rules, the issuer will be required to prepare disclosure for each 
relevant Rule 506 offering. The estimates include the time and the cost 
of data gathering systems, the time and cost of preparing and reviewing 
disclosure by in-house and outside counsel and executive officers, and 
the time and cost of delivering or furnishing documents and retaining 
records.
    Issuers conducting ongoing or continuous offerings will be required 
to update their factual inquiry and disclosure as necessary to address 
additional covered persons. The annual incremental paperwork burden, 
therefore, depends on an issuer's Rule 506 offering activity and the 
changes in covered persons from offering to offering. For example, some 
issuers may only conduct one Rule 506 offering during a year while 
other issuers may have multiple, separate Rule 506 offerings during the 
course of the same year involving different financial intermediaries, 
may hire new executive officers or may have new 20% shareholders, any 
of which will result in a different group of covered persons. In 
deriving our estimates, we recognize that the burdens will likely vary 
among individual companies based on a number of factors, including the 
size and complexity of their organizations. We believe that some 
companies will experience costs in excess of this estimated average and 
some companies may experience less than the estimated average costs.
Request for Comment
    Pursuant to 44 U.S.C. 3506(c)(2)(B), we request comment to:
     Evaluate whether the proposed collections of information 
are necessary for the proper performance of the functions of the 
Commission, including whether the information will have practical 
utility;
     Evaluate the accuracy of our estimate of the burden of the 
proposed collections of information;
     Determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected;
     Evaluate whether there are ways to minimize the burden of 
the collections of information on those who respond, including through 
the use of automated collection techniques or other forms of 
information technology; and
     Evaluate whether the proposed amendments will have any 
effects on any other collections of information not previously 
identified in this section.
    Any member of the public may direct to us any comments concerning 
the accuracy of these burden estimates and any suggestions for reducing 
the burdens. Persons who wish to submit comments on the collection of 
information requirements should direct their comments to OMB, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Room 10102, New Executive 
Office Building, Washington, DC 20503 and should send a copy to 
Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 
F Street NE., Washington, DC 20549-1090, with reference to File No. S7-
31-10. Requests for materials submitted to the OMB by us with regard to 
these collections of information should be in writing, refer to File 
No. S7-31-10 and be submitted to the Securities and Exchange 
Commission, Office of Investor Education and Advocacy, 100 F Street 
NE., Washington, DC 20549-0213. Because OMB is required to make a 
decision concerning the collections of information between 30 and 60 
days after publication, your comments are best assured of having their 
full effect if OMB receives them within 30 days of publication.

IV. Economic Analysis

A. Background and Summary of the Rule Amendments

    As discussed above, we are adopting amendments to implement the 
requirements of Section 926 of the Dodd-Frank Act, relating to the 
disqualification of ``felons and other `bad actors' '' from 
participation in Rule 506 offerings. Section 926 of the Dodd-Frank Act 
requires the Commission to issue rules that disqualify issuers making 
securities offerings involving felons and other bad actors from relying 
on Rule 506 of Regulation D. These rules are required to be 
``substantially similar'' to the disqualification rules in Rule 262 
(which apply to Regulation A offerings as well as offerings under Rule 
505 of Regulation D) and also to cover the matters enumerated in 
Section 926 (including certain state regulatory orders and bars). We 
believe the rules we are adopting comply with that mandate. The final 
rules include the following provisions not specifically required under 
Section 926:
     A reasonable care exception;
     Mandatory disclosure of triggering events pre-dating the 
effective date of the rule amendments;
     The inclusion of additional triggering events for certain 
orders of the CFTC and for Commission cease-and-desist orders relating 
to scienter-based anti-fraud violations and violations of Section 5 of 
the Securities Act;
     The addition of coverage of investment managers of pooled 
investment funds and directors, executive officers, other officers 
participating in the offering, general partners and managing members of 
such investment managers and directors, executive officers and other 
officers participating in the offering of such general partners and 
managing members;
     Narrower coverage of officers of issuers and financial 
intermediaries (covering only executive officers and officers 
participating in the offering, rather than all officers);
     Narrower coverage of shareholders of the issuer (covering 
only beneficial owners of at least 20% of the issuer's outstanding 
voting securities, calculated on the basis of voting power, rather than 
10% of any class of the issuer's equity securities); and
     A provision under which disqualification will not be 
triggered by regulatory orders if the authority that issued the order 
advises in writing that Rule 506 disqualification should not arise.
    While commenters had differing views on whether disqualification 
under Rule 506 could or should be applied to events that occurred 
before the effective date of the rule amendments, we determined to 
apply disqualification only to events that occur after effectiveness of 
the rule amendments.

[[Page 44753]]

As noted above, we are requiring disclosure of disqualifying events 
that pre-date effectiveness of the amendments.
    We are sensitive to the costs and benefits imposed by our rules. 
The discussion below attempts to address both the costs and benefits of 
Section 926 of the Dodd-Frank Act itself, as well as the incremental 
costs and benefits of the rules and rule amendments associated with the 
exercise of our discretion in implementing Section 926. The costs and 
benefits attributable to the statutory mandate and those attributable 
to our discretion may not be entirely separable to the extent that our 
discretion is exercised to realize the benefits that we believe were 
intended by the Dodd-Frank Act.
    Section 2(b) of the Securities Act \250\ requires us, when engaging 
in rulemaking where we are required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. We have 
considered those issues as part of this economic analysis.
---------------------------------------------------------------------------

    \250\ 15 U.S.C. 77b(b).
---------------------------------------------------------------------------

B. Economic Baseline

    The baseline analysis that follows is in large part based on 
information collected from Form D filings submitted by issuers relying 
on Regulation D to raise capital. As we describe in more detail below, 
we believe that we do not have a complete view of the Rule 506 market, 
particularly with respect to the amount of capital raised. Currently, 
issuers are required to file a Form D within 15 days of the first sale 
of securities, and are required to report additional sales through 
amended filings only under certain conditions. In addition, issuers may 
not report all required information, either due to error or because 
they do not wish to make the information public. Commenters have 
suggested and we also have evidence that some issuers do not file a 
Form D for their offerings in compliance with Rule 503.\251\ 
Consequently, the analysis that follows is necessarily subject to these 
limitations in the current Form D reporting process.
---------------------------------------------------------------------------

    \251\ Many commenters asserted that non-compliance with Form D 
filing obligations is widespread. See, e.g., letters from Investor 
Advisory Committee (stating that ``[i]t is generally acknowledged 
that a significant number of issuers do not currently file Form D. . 
.''); AARP (stating that ``[s]imply adding a checkbox to a form that 
too often goes unfiled and then only after the fact is inadequate to 
the task at hand.''); AFL-CIO and AFR (stating that ``many issuers 
today flout the Form D filing requirement for such offerings, 
further limiting the Commission's ability to provide effective 
oversight''). See also Securities and Exchange Commission, Office of 
Inspector General, Regulation D Exemption Process (Mar. 31, 2009) 
(``OIG Report''), available at: http://www.sec-oig.gov/Reports/AuditsInspections/2009/459.pdf (stating that while the Commission 
staff ``strongly encourage companies to comply with Rule 503, they 
are aware of instances in which issuers have failed to comply with 
Rule 503 . . .''). Based on its analysis of the filings required by 
FINRA Rules 5122 and 5123 during the period of December 3, 2012 to 
February 5, 2013, DERA estimates that as many as 9% of the offerings 
represented in the FINRA filings for Regulation D or other private 
offerings that used a registered broker did not have a corresponding 
Form D.
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1. Size of the Exempt Offering Market
    Exempt offerings play a significant role in capital formation in 
the United States. Offerings conducted in reliance on Rule 506 account 
for 99% of the capital reported as being raised under Regulation D from 
2009 to 2012, and represent approximately 94% of the number of 
Regulation D offerings.\252\ The significance of Rule 506 offerings is 
underscored by the comparison to registered offerings. In 2012, the 
estimated amount of capital reported as being raised in Rule 506 
offerings (including both equity and debt) was $898 billion, compared 
to $1.2 trillion raised in registered offerings.\253\ Of this $898 
billion, operating companies (issuers that are not pooled investment 
funds) reported raising $173 billion, while pooled investment funds 
reported raising $725 billion.\254\ The amount reported as being raised 
by pooled investment funds is comparable to the amount of capital 
raised by registered investment funds. In 2012, registered investment 
funds (which include money market mutual funds, long-term mutual funds, 
exchange-traded funds, closed-end funds and unit investment trusts) 
raised approximately $727 billion.\255\
---------------------------------------------------------------------------

    \252\ See Vladimir Ivanov and Scott Bauguess, Capital Raising in 
the U.S.: An Analysis of Unregistered Offerings Using the Regulation 
D Exemption, 2009-2012 (July 2013), available at http://www.sec.gov/divisions/riskfin/whitepapers/dera-unregistered-offerings-reg-d.pdf 
(``Ivanov/Bauguess Study'').
    \253\ See id.
    \254\ See id.
    \255\ In calculating the amount of capital raised by registered 
investment funds, we use the net amounts (plus reinvested dividends 
and reinvested capital gains), which reflect redemptions, and not 
gross amounts, by open-ended registered investment funds because 
they face frequent redemptions, and do not have redemption 
restrictions and lock-up periods common among private funds. In 
addition, we use the new issuances of registered closed-end funds 
and the new deposits of registered unit investment trusts. See 2013 
Investment Company Institute Factbook, available at http://www.icifactbook.org.
---------------------------------------------------------------------------

    In 2011, the estimated amount of capital (including both equity and 
debt) reported as being raised in Rule 506 offerings was $849 billion 
compared to $985 billion raised in registered offerings.\256\ Of the 
$849 billion, operating companies reported raising $71 billion, while 
pooled investment funds reported raising $778 billion.\257\ More 
generally, when including offerings pursuant to other exemptions--Rule 
144A, Regulation S and Section 4(a)(2)--significantly more capital 
appears to be raised through exempt offerings than registered offerings 
(Figure 1).\258\
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    \256\ See Ivanov/Bauguess Study.
    \257\ See id.
    \258\ See id.

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[[Page 44754]]

[GRAPHIC] [TIFF OMITTED] TR24JY13.005

    At present, issuers  are required to file a Form D not later than 
15 days after the first sale of securities in a Regulation D offering 
and an amendment to the Form D only under certain circumstances. Since 
issuers are not required to submit a filing when an offering is 
completed, and submit amendments only under certain circumstances, we 
have no definitive information on the final amounts raised. Figure 2, 
below, illustrates that at the time of the initial Form D filing, only 
39% of offerings by non-pooled investment fund issuers were completed 
relative to the total amount sought. Separately, 70% of pooled 
investment funds state their total offering amount to be ``Indefinite'' 
in their Form D filings. As a result, the initial Form D filings of 
these pooled investment funds likely do not accurately reflect the 
total amount of securities offered or sold.
---------------------------------------------------------------------------

    \259\ The 2012 non-ABS Rule 144A offerings data is based on an 
extrapolation of currently available data through May 2012 from 
Sagient Research System's Placement Tracker database. For more 
detail, see the Ivanov/Bauguess Study.
[GRAPHIC] [TIFF OMITTED] TR24JY13.006

2. Affected Market Participants
    The amendments to Rule 506 we are adopting today will affect a 
number of different market participants. Issuers of securities in Rule 
506 offerings include both reporting and non-reporting operating 
companies and pooled investment funds. Investment advisers organize and 
sponsor pooled investment

[[Page 44755]]

funds that conduct Rule 506 offerings. Intermediaries that facilitate 
Rule 506 offerings include registered broker-dealers, finders and 
placement agents. Investors in Rule 506 offerings include accredited 
investors (both natural persons and legal entities) and non-accredited 
investors who meet certain ``sophistication'' requirements. Each of 
these market participants is discussed in further detail below.
a. Issuers
    Based on the information submitted in 112,467 new and amended Form 
D filings between 2009 and 2012, there were 67,706 new Regulation D 
offerings by 49,740 unique issuers during this four-year period.\260\ 
The size of the average Regulation D offering during this period was 
approximately $30 million, whereas the size of the median offering was 
approximately $1.5 million.\261\ The difference between the average and 
median offering sizes indicates that the Regulation D market is 
comprised of many small offerings, which is consistent with the view 
that many smaller businesses are relying on Regulation D to raise 
capital, and a smaller number of much larger offerings.
---------------------------------------------------------------------------

    \260\ See Ivanov/Bauguess Study.
    \261\ See id. The average and median amounts are calculated 
based on the amounts sold by Regulation D issuers as reported in 
their Form D filings. A study of unregistered equity offerings by 
publicly-traded companies over the period 1980-1996 found that the 
mean offering amount was $12.7 million, whereas the median offering 
amount was $4.5 million. See M. Hertzel, M. Lemon, J. Linck, and L. 
Rees, Long-Run Performance Following Private Placements of Equity, 
57 Journal of Finance (2002), 2595-2617.
---------------------------------------------------------------------------

    Some information about issuer size is available from Item 5 in Form 
D, which calls for issuers in Regulation D offerings to report their 
size in terms of revenue ranges or, in the case of certain pooled 
investment funds, net asset value ranges. All issuers can currently 
choose not to disclose this size information, however, and a 
significant majority of issuers that are not pooled investment funds 
declined to disclose their revenue ranges in the Forms D that they 
filed between 2009 and 2012. For those that did, most reported a 
revenue range of less than $1 million (Figure 3).\262\ During the 2009-
2011 period, approximately 10% of all public companies raised capital 
in Regulation D offerings; in 2012, approximately 6% of such companies 
did so.\263\ These public companies tended to be smaller and less 
profitable than their industry peers, which illustrates the 
significance of the private capital markets to smaller companies, 
whether public or private.\264\
---------------------------------------------------------------------------

    \262\ See Ivanov/Bauguess Study.
    \263\ Id. (explaining methodology of using listings in the 
Standard & Poor's Compustat database and the University of Chicago's 
Center for Research in Securities Prices database to determine which 
companies were public companies).
    \264\ Id.
    [GRAPHIC] [TIFF OMITTED] TR24JY13.007
    
    During this period, pooled investment funds conducted approximately 
24% of the total number of Regulation D offerings and raised 
approximately 81% of the total amount of capital raised in Regulation D 
offerings.\265\ More than 75% of pooled investment funds declined to 
disclose their net asset value range.
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    \265\ Id.

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[[Page 44756]]

[GRAPHIC] [TIFF OMITTED] TR24JY13.008

    Between 2009 and 2012, approximately 66% of Regulation D offerings 
were of equity securities, and almost two-thirds of these were by 
issuers other than pooled investment funds.\266\ Non-U.S. issuers 
accounted for approximately 19% of the amount of capital raised in 
Regulation D offerings, indicating that the U.S. market is a 
significant source of capital for these issuers.\267\
---------------------------------------------------------------------------

    \266\ Id.
    \267\ Id.
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b. Investors
    We have relatively little information on the types and number of 
investors in Rule 506 offerings. Form D currently requires issuers in 
Rule 506 offerings to provide information about the total number of 
investors who have already invested in the offering and the number of 
persons who do not qualify as accredited investors.\268\ In 2012, 
approximately 153,000 investors participated in offerings by operating 
companies, while approximately 81,000 investors invested in offerings 
by pooled investment funds.\269\ Because some investors participate in 
multiple offerings, these numbers likely overestimate the actual number 
of unique investors in these reported offerings. In offerings under 
Rule 506(b), both accredited investors and up to 35 non-accredited 
investors who meet certain sophistication requirements are eligible to 
purchase securities. In offerings under new Rule 506(c), only 
accredited investors will be eligible to purchase securities.
---------------------------------------------------------------------------

    \268\ See Item 14 of Form D. Form D does not require any other 
information on the types of investors, such as whether they are 
natural persons or legal entities.
    \269\ These numbers are based on initial Form D filings 
submitted in 2012.
---------------------------------------------------------------------------

    Information collected from Form D filings indicates that most Rule 
506 offerings do not involve broad investor participation. More than 
two-thirds of these offerings have ten or fewer investors, while less 
than 5% of these offerings have more than 30 investors. Although Rule 
506 currently allows for the participation of non-accredited investors 
who meet certain sophistication requirements, such non-accredited 
investors reportedly purchased securities in only 11% of the Rule 506 
offerings conducted between 2009 and 2012.\270\ Only 8% of the 
offerings by pooled investment funds included non-accredited investors, 
compared to 12% of the offerings by other issuers.\271\
---------------------------------------------------------------------------

    \270\ See Ivanov/Bauguess Study.
    \271\ Id.

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[[Page 44757]]

[GRAPHIC] [TIFF OMITTED] TR24JY13.009

    As stated above, between 2009 and 2012, the size of the median 
Regulation D offering, based on the information in Form D filings, was 
approximately $1.5 million. The presence of so many relatively small 
offerings suggests that a sizable number of current investors in Rule 
506 offerings are natural persons or legal entities in which all equity 
owners are natural persons. This is because smaller offerings may not 
provide sufficient scale for institutional investors to earn a sizable 
return. Institutional investors typically have a larger investible 
capital base and more formal screening procedures compared to investors 
who are natural persons, and the associated costs of identifying 
potential investments and monitoring their investment portfolio lead 
them to make larger investments than natural persons.\272\ As for 
whether natural persons investing in these offerings are accredited 
investors or non-accredited investors, almost 90% of the Regulation D 
offerings conducted between 2009 and 2012 did not involve any non-
accredited investors.\273\
---------------------------------------------------------------------------

    \272\ See, e.g., George Fenn, Nellie Liang and Stephen Prowes, 
The Economics of Private Equity Markets. (1998); Steven Kaplan and 
Per Stromberg, Leveraged Buyouts and Private Equity, Journal of 
Economic Perspectives (2009).
    \273\ See Ivanov/Bauguess Study.
---------------------------------------------------------------------------

    While we do not know what percentage of investors in Rule 506 
offerings are natural persons, the vast majority of Regulation D 
offerings are conducted without the use of an intermediary,\274\ 
suggesting that many of the investors in Regulation D offerings likely 
have a pre-existing relationship with the issuer or its management 
because these offerings would not have been conducted using general 
solicitation. This category of investors is likely to be much smaller 
than the total number of eligible investors for Rule 506(c) offerings, 
which is potentially very large. We estimate that at least 8.7 million 
U.S. households, or 7.4% of all U.S. households, qualified as 
accredited investors in 2010, based on the net worth standard in the 
definition of ``accredited investor'' (Figure 6).\275\
---------------------------------------------------------------------------

    \274\ An analysis of all Form D filings submitted between 2009 
to 2012 shows that approximately 11% of all new offerings reported 
sales commissions of greater than zero because the issuers used 
intermediaries. See Ivanov/Bauguess Study. We assume that the lack 
of a commission indicates the absence of an intermediary.
    \275\ This estimate is based on net worth and household data 
from the Federal Reserve Board's Triennial Survey of Consumer 
Finances (``SCF'') 2010. Our calculations are based on 32,410 
observations in the 2010 survey.

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[[Page 44758]]

[GRAPHIC] [TIFF OMITTED] TR24JY13.010

    Our analysis, however, leads us to believe that only a small 
percentage of these households are likely to participate in securities 
offerings, especially exempt offerings. First, as mentioned above, data 
from Form D filings in 2012 suggests that fewer than 234,000 investors 
(of which an unknown subset are natural persons) participated in 
Regulation D offerings, which is small compared to the 8.7 million 
households that qualify as accredited investors. Second, evidence 
suggests that only a small fraction of the total accredited investor 
population has significant levels of direct stockholdings. Based on an 
analysis of retail stock holding data for 33 million brokerage accounts 
in 2010, only 3.7 million accounts had at least $100,000 of direct 
investments in equity securities issued by public companies listed on 
domestic national securities exchanges, while only 664,000 accounts had 
at least $500,000 direct investments in such equity securities (Figure 
7).\276\ Assuming that investments in publicly-traded equity securities 
are a gateway to investments in securities issued in exempt offerings, 
and accredited investors with investment experience in publicly-traded 
equity securities are more likely to participate in an exempt offering 
than accredited investors who do not, the set of accredited investors 
likely to be interested in investing in Rule 506(c) offerings could be 
significantly smaller than the total accredited investor population.
---------------------------------------------------------------------------

    \276\ This analysis by DERA is based on the stock holdings of 
retail investors from more than 100 brokerage firms covering more 
than 33 million accounts during the period June 2010-May 2011.

---------------------------------------------------------------------------

[[Page 44759]]

[GRAPHIC] [TIFF OMITTED] TR24JY13.011

c. Investment Managers
    Based on Form ADVs that were filed with the Commission as of June 
2013, there were 7,772 SEC reporting investment advisers that have 
clients that are private funds, registered investment companies 
business development companies, or other pooled investment vehicles. 
These investment advisers include:
     Registered investment advisers. Data filed for 2012 show 
that there were approximately 5,400 Commission-registered investment 
advisers with pooled investment fund clients that filed Form ADV with 
the Commission. These 5,400 investment advisers represent approximately 
$45.3 trillion total assets under management for pooled investment 
funds, or average assets under management of $8.4 billion per adviser. 
Of these, 4,044 investment advisers had clients that were private 
funds, with total assets under management of $35.2 billion and average 
assets under management of $8.6 billion.
     Exempt reporting advisers. These are investment advisers 
that are required to report on Form ADV but not to register with the 
Commission (for example, investment advisers to venture capital funds). 
Based on ADV data, there were 2,303 exempt reporting advisers in 2012, 
all of which had pooled investment funds as clients, with approximately 
$1.6 trillion of assets under management.
    We do not have information regarding investment advisers with 
assets under management of less than $100 million, which are not 
generally required to register with the Commission, or investment 
managers that advise pooled investment funds with respect to 
investments in assets other than securities, such as commodities or 
real estate.
d. Broker-Dealers
    As of December 2012, there were 4,450 broker-dealers registered 
with the Commission who file on Form X-17A-5, with average total assets 
of approximately $1.1 billion per broker-dealer. The aggregate total 
assets of these registered broker-dealers are approximately $4.9 
trillion. Of these registered broker-dealers, 410 are dually registered 
as investment advisers. The dually registered broker-dealers are larger 
(average total assets of $6.4 billion) than those that are not dually 
registered. Among the dually registered broker-dealers, we identified 
24 that currently have or have had private funds that submitted Form D 
filings between 2002 and 2012.
3. Estimated Incidence of ``Bad Actors'' in Securities Markets 
Generally
    The economic impact of the rule amendments primarily depends on the 
extent to which they succeed in reducing fraud in the Rule 506 
marketplace. This, in turn, depends on multiple factors, including the 
incidence of bad actors in Rule 506 offerings, the recidivism rate of 
such bad actors and the potential deterrent effect of disqualification 
as a sanction.
    The disqualification rules should reduce the participation of both 
new and existing bad actors in Rule 506 offerings. Offerings will no 
longer be eligible to rely on Rule 506 if they involve a covered person 
that becomes a bad actor because of a triggering event that occurs 
after the new rules take effect. While triggering events existing 
before effectiveness of the rule will not be disqualifying, issuers 
will be required to provide disclosure about such events to investors. 
Participation in Rule 506 offerings by bad actors not disqualified by 
the rules we adopt today may, therefore, also be limited if issuers or 
investors are reluctant to transact with bad actors or participate in 
transactions involving bad actors once they become aware of the bad act 
through the required disclosure.
    The effects of disqualification also depend on the likelihood that 
participation of bad actors in Rule 506 offerings would lead to the 
recurrence in perpetration of triggering events. This depends on the 
recidivism rates among bad actors.

[[Page 44760]]

    Finally, the passage of the rule, through the deterrent effect of a 
potential threat of disqualification, could have the indirect impact of 
reducing the number of bad actors in the securities markets and the 
conduct resulting in sanctions that trigger disqualification.
    Although it is impossible to predict future market participant 
behavior that may arise in response to the adopted rules, we can 
quantify, in certain instances, past occurrences of certain triggering 
events to provide an estimate of the historical incidence of bad 
actors--as determined under the new rules--in securities markets as a 
general matter.
    Identification of Triggering Events. To assess the incidence in the 
securities markets of potentially disqualifying ``bad actors,'' we 
examined the legal proceedings brought by the Commission during the 
five-year period from 2007 to 2011 in which the sanctions imposed would 
constitute triggering events under the new rule. We searched records of 
public proceedings, including case name, defendant name, code section 
violation, and sanction. To conduct the search, we used search terms 
pertaining to:
     Injunctions and court orders (which we refer to 
collectively as ``injunctions'') against conduct or practices in 
connection with the purchase or sale of a security, involving the 
making of a false filing with the Commission, or arising out of the 
conduct of business of certain financial intermediaries, as provided in 
Rule 506(d)(1)(ii);
     Commission disciplinary orders under Section 15(b) or 
15B(c) of the Exchange Act or Section 203(e) or (f) of the Advisers Act 
that suspend or revoke registration, limit activities or bar a person 
from association with a regulated entity or from participation in a 
penny stock offering, as provided in Rule 506(d)(1)(iv); and
     Commission cease-and-desist orders relating to violations 
of scienter-based anti-fraud provisions of the federal securities laws 
or violations of Section 5 of the Securities Act, as provided in Rule 
506(d)(1)(v).

Our analysis did not consider other bad actor triggering events in Rule 
506(d)(1), primarily because we do not have a comparable ability to 
search databases relevant to criminal convictions or the actions of 
relevant state and other federal regulators.\277\ In addition, it is 
possible that the search techniques used by staff may not have 
identified all relevant potential triggering events and bad actors. 
Since our analysis is subject to these limitations, our estimates of 
the incidence of potential bad actors likely represent a lower bound. 
On the other hand, not all of the bad actors identified in our search 
would be expected to be involved with Rule 506 offerings.
---------------------------------------------------------------------------

    \277\ We have limited information available on enforcement 
activity by state securities regulators, discussed at the text 
accompanying note 283. Our analysis did not cover felony and 
misdemeanor convictions as provided in Rule 506(d)(1)(i); final 
orders of state authorities and Federal banking agencies and 
National Credit Union Association as provided in Rule 
506(d)(1)(iii); disciplinary actions by a national securities 
exchange or an affiliated securities association, as provided in 
Rule 506(d)(1)(vi); and United States Postal Service orders as 
provided in Rule 506(d)(vii). We also excluded refusal, stop, or 
suspension orders pertaining to registration statements or 
Regulation A offering statements, as provided in Rule 
506(d)(1)(vii), because they are too infrequent to affect our 
analysis.
---------------------------------------------------------------------------

    Our search of Commission enforcement actions identified a sample of 
2,578 persons, including both individuals and entities, that received 
injunctions, disciplinary orders, and/or cease-and-desist orders, 
issued in a total of 1,485 enforcement cases over the five-year period. 
We found that an aggregate of 3,053 disqualifying sanctions (1,943 
injunctions, 853 disciplinary orders, and 257 cease-and-desist orders) 
were imposed upon these persons. In some instances, a person received 
more than one sanction, which in most cases consisted of a combination 
of an injunction and a disciplinary order.\278\ Each one of these 
sanctions would have constituted a triggering event under this rule, 
which would have disqualified any offering from relying on Rule 506 if 
the person were a ``covered person,'' such as a director or executive 
officer of the issuer or a financial intermediary. The following chart 
shows the breakdown of triggering events by type:
---------------------------------------------------------------------------

    \278\ One case involving both an injunction and a cease-and-
desist order is not reflected in the chart titled ``Triggering 
Events: 2007-2011'' due to rounding.
[GRAPHIC] [TIFF OMITTED] TR24JY13.012


[[Page 44761]]


In the cases we identified, between 70% and 78% of triggering events 
each year were against individuals, with the remainder against 
entities. With 83,521 offerings that relied on Rule 506 during the 
period under review, the incidence of detected bad actors is 
approximately 0.03 per offering. These numbers represent, however, only 
enforcement actions brought by the Commission. These numbers do not 
reflect enforcement action by other authorities (for example, state 
level regulators), nor do they include undetected bad actors.
    While all of the 2,578 identified bad actors would disqualify any 
offering in which they were involved from reliance on Rule 506, not all 
of the bad actors would be expected to be involved with Rule 506 
offerings. Many of the triggering events, such as insider trading, 
involve bad actors engaged in secondary market transactions. These 
persons may present a lesser risk of entering primary issuance markets 
such as Rule 506. Hence, the aggregate number of bad actors may 
overestimate the incidence of bad actors operating in the Rule 506 
market. To more accurately estimate the likelihood that a bad actor 
might be involved in the issuance of securities, we identify triggering 
events involving a Section 5 violation.\279\ As reflected in the chart 
``Bad Actors by Year and Violation'' below, approximately 29% of the 
bad actors (a total of 748) were sanctioned for Section 5 violations. A 
similar percentage, approximately 25%, were sanctioned for the next-
largest category of violations, those involving false filings.\280\ The 
remaining bad actors fall into the ``Other'' category, of which insider 
trading-related violations represent the largest single sub-category. 
The following chart shows this breakdown:
---------------------------------------------------------------------------

    \279\ Bad actors included in the Section 5 category may have 
also violated other securities law provisions, such as anti-fraud 
provisions in Section 17(a) of the Securities Act and Section 10(b) 
of the Exchange Act. Using Section 5 violations as a proxy for 
involvement in a securities offering may be under inclusive, as 
there may be offering-related misconduct without a Section 5 
violation.
    \280\ We define false filing as violations relating to errors 
and omissions in Commission filings, such as periodic reports, Form 
BD, Form ADV and beneficial ownership reports.
[GRAPHIC] [TIFF OMITTED] TR24JY13.013

    To assess the quality of the search results, from the 1,485 cases 
previously identified, we selected a random sample of 190 cases, a 
sample that is large enough to provide a low margin of error. Because a 
single case produces multiple triggering events if multiple persons are 
named, the sample of 190 cases included 529 potential triggering events 
and allows for a margin of error of less than 5% in our analysis.\281\ 
Commission staff reviewed the orders, releases, and other documentation 
for all 190 cases to determine whether each potential triggering event 
actually met the criteria specified in Rule 506(d)(1)(ii), (iv) or (v). 
The review of the search results showed that the search criteria 
applied produced relatively accurate results.\282\
---------------------------------------------------------------------------

    \281\ The margin of error in these estimates based on the sample 
size of 529 potential triggering events is approximately 3.6% at the 
90% confidence level. Taking these results together, there may be as 
many as 30 more or 30 fewer disciplinary orders than what is 
estimated at the 90% confidence level.
    \282\ The misclassification rate for injunctions, disciplinary 
orders, and cease and desist orders was 4%, 30%, and 0% 
respectively. While the misclassification rate for disciplinary 
orders was high, the sample results for disciplinary orders 
contained nearly the same number of false positives (events 
classified as disciplinary orders that did not actually meet the 
criteria of Rule 506(d)(1)(iv)) as false negatives (events 
classified as injunctions and/or cease-and-desist orders that turned 
out to also include disciplinary orders), so the error in the total 
number of estimated disciplinary orders based on the sample review 
is significantly less than 30%. Accounting for offsetting 
misclassifications--i.e., false positives and false negatives--the 
error rate in the total number of estimated disciplinary orders 
falls to 1%.
---------------------------------------------------------------------------

    Incidence of Bad Actors Potentially Participating in Primary 
Offerings of Securities. Staff further refined the estimate of the 
likelihood that triggering events that were related to the Rule 506 
market using the random sample of 190 cases. In particular, staff 
identified whether each of the cases involved an offering of securities 
by the issuer, which we refer to as a primary offering. For cases 
involving a primary offering, staff identified whether the offering was 
registered or unregistered. The review showed that 70 out of the 190 
cases (or

[[Page 44762]]

37%) involved a primary offering, all of which were unregistered, and 
of the 529 potential triggering events included in the 190 cases, 251 
(or 47%) involved a primary offering.
    For purposes of the review, defendants or respondents were 
categorized as ``issuers,'' ``intermediaries,'' and ``other persons.'' 
``Issuers'' are entities that issue securities and the individuals who 
were affiliated with that issuer. ``Intermediaries'' are entities and 
individuals that facilitate securities offerings and investments, like 
brokers and non-affiliated investment advisers. ``Other persons'' are 
persons who are neither issuers nor intermediaries; the staff found 
that, in general, these were persons found liable for trading on inside 
information.
    The following table summarizes the staff's findings with respect to 
these cases:

       Summary of Bad Actors and Case Type for 2007 to 2011 Period
------------------------------------------------------------------------
                                                       Subset of sample
                                   Random sample of       relating to
                                   enforcement cases     unregistered
                                                           offerings
------------------------------------------------------------------------
Number of cases.................                 190            70 (37%)
Number of triggering events                      529           251 (47%)
    --issuers...................                 278                 160
    --intermediaries............                 189                  76
    --entities acting as both                     17                  15
     issuers and intermediaries.
    --other persons.............                  45                   0
------------------------------------------------------------------------

    Of the 529 bad actors in the sample, staff found that 278 were 
issuers, 189 were intermediaries, 17 were entities that could qualify 
as either an issuer or an intermediary (such as a promoter who is 
employed by an issuer), and 45 were other persons.
    Based on projections from our review of this sample, we estimate 
that during the 2007 to 2011 review period, 549 cases (37% of the 1,485 
total cases) involved an unregistered offering and approximately 1,212 
bad actors (47% of the 2,578 total bad actors identified) participated 
in those unregistered offerings. We consider these estimates as a lower 
bound for the number of bad actors because our analysis does not take 
into account bad actor triggering events other than those in 
subsections (ii), (iv), and (v) of Rule 506(d)(1) or offerings 
involving bad actors that did not give rise to enforcement activity. 
Taking those into account, the total number of bad actors is likely to 
be higher.
    We considered other data sources regarding the number of bad actor 
triggering events not involving Commission action. NASAA's 2012 
Enforcement Report presents some data on orders by state securities 
regulators between 2009 and 2011,\283\ which would pertain to 
subsection (iii) of Rule 506(d)(1), relating to final orders and bars 
issued by state securities, insurance and banking regulators, federal 
banking regulators and the National Credit Union Administration. The 
report states that, as a result of state securities regulatory actions, 
8,744 licenses were withdrawn and 1,952 licenses were denied, revoked, 
suspended, or conditioned in that three-year period. This data, 
however, may be over inclusive for purposes of establishing the number 
of bad actors under Rule 506(d) for a number of reasons. First, not all 
of the actions appear to be ``final orders'' under subsection (iii) of 
Rule 506(d)(1) (e.g., some licenses were withdrawn rather than 
revoked). In addition, there is potential double counting in the NASAA 
survey when different states take action against the same person, as 
well as potential double counting between Commission and NASAA data for 
bad actors subject to both Commission and state sanctions. The data 
could also be under inclusive, in that it covers only actions by state 
securities regulators, whereas under subsection (iii) of Rule 
506(d)(1), disqualification may also be triggered by orders of state 
insurance, banking, savings association and credit union regulators; 
appropriate federal banking regulators; and the National Credit Union 
Association. Staff were not able to identify comparable sources of data 
on these other types of orders.\284\
---------------------------------------------------------------------------

    \283\ North American Securities Administrators Association, 2012 
Enforcement Report, Table 4 (available at http://www.nasaa.org/wp-content/uploads/2011/08/2012-Enforcement-Report-on-2011-Data1.pdf).
    \284\ FINRA's BrokerCheck database includes this data for 
registered broker-dealers and their associated persons, as well as 
data on investment advisers and their associated persons drawn from 
the Commission's IARD database. See note 202. BrokerCheck is 
searchable only by the name of firms and individuals, however, not 
by the nature of past violations, which makes it impracticable for 
us to use it as a source of data in this review.
---------------------------------------------------------------------------

C. Analysis of Final Rules

    Section 926 of the Dodd-Frank Act requires the Commission to adopt 
rules excluding felons and other bad actors from participation in Rule 
506 offerings. The disqualification provisions of Rule 506 were 
intended to \285\ and should lead to enhanced investor protection by 
reducing the number of offering participants who have previously 
engaged in fraudulent activities or who previously violated securities, 
insurance, banking or credit union laws or regulations, and by 
providing an additional deterrent to future fraudulent activities. 
Currently, persons covered by the disqualification provisions of these 
rules, such as issuers and compensated solicitors, are subject to a 
multilayered securities enforcement system that includes the 
Commission, state securities regulators and, for financial industry 
participants, FINRA. The disqualification rules we adopt today should 
alter industry practice by inducing issuers and other covered persons 
to implement additional measures to restrict bad actor participation in 
Rule 506 offerings.
---------------------------------------------------------------------------

    \285\ Statement of Senator Christopher Dodd, 156 Cong. Rec. 
S3813 (daily ed. May 17, 2010).
---------------------------------------------------------------------------

    In the proposing release, we solicited comment on the costs and 
benefits of the proposed rules. While no comment letters provided 
quantitative data or directly addressed the cost-benefit analysis 
included in the proposing release, a number of commenters did mention 
potential costs and benefits of the proposed rule. Our response to 
these comments is discussed in Section II above, and we briefly discuss 
these comments where they are relevant in the discussion below.
1. Effects of the Statutory Mandate
    To the extent the new disqualification provisions result in a 
reduction of fraud in the Rule 506 offering market, investor losses to 
fraud will be reduced and investor willingness to participate in the

[[Page 44763]]

Rule 506 market could increase. This should lower the issuance costs 
for Rule 506 offerings to the extent that new disqualification 
standards lower the risk premium associated with the presence of bad 
actors in securities offerings.\286\ Lower costs in the Rule 506 
offering market could improve conditions for capital formation, 
benefitting both issuers and investors. In this regard, commenters also 
emphasized investor protection \287\ and increased participation in the 
private placement market as the main benefits of the rule.\288\
---------------------------------------------------------------------------

    \286\ In a related framework, Karpoff et al. (2008) show that 
the marketplace imposes significant penalties on firms targeted by 
SEC enforcement actions for financial misrepresentation, where for 
each dollar of misrepresentation the firm loses an additional $3.08 
due to expected legal penalties and loss of reputation. See J. 
Karpoff, D. Lee & G. Martin, The Cost to Firms of Cooking the Books, 
581-611 Journal of Financial & Quantitative Analysis (Sept. 2008).
    \287\ See comment letters from M. Zhu; DTC; Better Markets; 
NASAA.
    \288\ See comment letter from Better Markets.
---------------------------------------------------------------------------

    The new disqualification provisions may also benefit investors by 
reducing the burden of the ``due diligence'' investigation they conduct 
on persons and entities involved in the offerings in which they invest. 
Without bad actor disqualification, investors seeking information about 
the background of issuers and the people involved with them would have 
to perform separate investigations due to the cost of coordinating 
collective action. Requiring issuers to determine whether any persons 
or entities are subject to an event that triggers disqualification may, 
for some investors, obviate the need to do their own investigation, 
which may eliminate some of the redundancies in these separate 
investigations. Given the issuer's advantage in accessing much of the 
relevant information, issuers should be able to perform the task at a 
lower cost than most individual investors.
    The disqualification requirements also impose costs on issuers, 
covered persons and investors. In our analysis under the Paperwork 
Reduction Act in Part III.B above, we estimate that most issuers will 
bear an additional cost of $400 to conduct a factual inquiry to 
determine whether any covered persons had a disqualifying event that 
occurred before the effective date of the rule amendments.\289\ We also 
estimate that approximately 220 \290\ Rule 506 issuers will spend 
$5,200 on average for using in-house and outside professional services 
in preparing a disclosure statement describing matters that would have 
triggered disqualification under Rule 506(d)(1) of Regulation D had 
they occurred on or after the effective date of the rule amendments. 
These cost estimates are based on assumptions outlined in Part IV.B.3 
above and represent lower bound estimates, given that our analysis in 
Part IV.B.3 did not cover all possible bad actor triggering events. We 
note, in addition, that the Paperwork Reduction Act analysis is not 
required to, and does not, consider all potential costs that market 
participants may incur in complying with Rule 506(d). Further, we 
cannot predict how issuers will respond to the possibility of having to 
disclose the participation of a bad actor in an offering; the issuer 
could disclose, remove the person from the offering, abandon the 
offering, or conduct an offering that does not require disclosure.
---------------------------------------------------------------------------

    \289\ We assume the cost of in-house attorney services to be 
$400 per hour. This estimate is based on data provided in the report 
titled Management and Professional Earnings in the Securities 
Industry--2012, which is published by the Securities Industry and 
Financial Markets Association.
    \290\ Staff estimates that there were at least 549 SEC 
enforcement actions involving an unregistered offering in which 
someone who would be disqualified as a bad actor participated in the 
five years from 2007 through 2011. See Part IV.B.3.
---------------------------------------------------------------------------

    Issuers that are disqualified from reliance on Rule 506 will bear 
costs to the extent that alternative means of raising capital are 
unavailable or involve higher transaction costs that result in a higher 
cost of capital. In some circumstances, issuers may postpone or forgo 
capital raising, deferring engagement in potentially value-enhancing 
projects. This could entail forgone investment opportunities for 
disqualified issuers and for investors who otherwise would have 
invested in such issuers. Issuers that pursue alternative capital 
raising methods may incur higher costs associated with their capital 
raising. For example, all other things being equal, transaction costs 
are likely to be higher for issuers that raise capital in reliance on 
Section 4(a)(2) of the Securities Act outside of Rule 506 because of 
higher costs to comply with state securities law requirements and 
greater legal uncertainty about the requirements of the exemption. In 
addition, issuers eligible to rely on new Rule 506(c) will be able to 
use general solicitation and general advertising to find potential 
investors if all purchasers in their offering are accredited investors 
and the issuer takes reasonable steps to verify their accredited 
investor status,\291\ whereas issuers seeking an exemption under 
Section 4(a)(2) outside of Rule 506(c) will continue to be constrained 
by the incompatibility of a claim of exemption under Section 4(a)(2) 
and general solicitation or general advertising.\292\ This may further 
differentiate transaction costs and cost of capital between Section 
4(a)(2) offerings and Rule 506(c) offerings. Registered securities 
offerings can also result in higher transaction costs than private 
offerings, and in addition trigger ongoing reporting 
responsibilities.\293\ As highlighted above, 22% of Rule 506 issuers 
that reported revenues on Form D indicated that their revenues were 
less than $1 million. For these and similarly sized issuers, going 
public through a registered offering may not be a feasible substitute 
for a Rule 506 offering.\294\
---------------------------------------------------------------------------

    \291\ As discussed above, we are adopting new Rule 506(c), 17 
CFR 230.506(c), today. See Eliminating the Prohibition Against 
General Solicitation and General Advertising in Rule 506 and Rule 
144A Offerings, Release No. 33-9415 (July 10, 2013).
    \292\ Id. at note 42 and accompanying text.
    \293\ A 2011 report prepared by a group called the ``IPO Task 
Force,'' which consisted of a group of professionals, including 
venture capitalists, experienced CEOs, public investors, securities 
lawyers, academics and investment bankers, estimated that the cost 
of going and staying public are high. Chart H of the IPO Task Force 
Report estimates that the average cost to go public is $2.5 million 
and the annual cost of staying public is $1.5 million. See 
Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job 
Market Back on the Road to Growth (publicly available at http://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf).
    \294\ For example, if an issuer intends to raise a small amount 
of capital to fund its operations, the costs of conducting a 
registered offering may make a registered offering impracticable. In 
addition, private funds that rely on exemptions from investment 
company registration under Section 3(c)(1) or 3(c)(7) of the 
Investment Company Act are not permitted to conduct public 
securities offerings.
---------------------------------------------------------------------------

    Issuers may also incur costs in connection with changes to 
personnel, governance structures and capital raising plans as a result 
of disqualification. For example, issuers may incur costs from 
terminating disqualified individuals or from reassigning them to 
positions where they will not trigger a disqualification in the context 
of an offering, and hiring new personnel or retraining existing 
personnel to replace them. They may also incur costs incident to 
restructuring their governance and control arrangements if, for 
example, a general partner, managing member or investment manager of a 
pooled investment fund issuer is a bad actor whose involvement would 
result in the disqualification of the offering. Issuers may also incur 
costs in connection with terminating an engagement with a placement 
agent or other covered financial intermediary, and entering into a new 
engagement. Smaller issuers and issuers with limited operating 
histories may not be able to readily find a new placement agent or 
other financial intermediary.

[[Page 44764]]

    The final rule will include as covered persons the beneficial 
owners of 20% or more of the issuer's outstanding voting equity, 
calculated on the basis of voting power. This reflects a change from 
the 10% or more beneficial ownership of any class of the issuer's 
equity originally proposed. The higher ownership standard, limitation 
to voting securities and calculation focused on voting power would 
increase the likelihood that the disqualified investor is more closely 
affiliated with the issuer and has greater input or control over the 
management of the issuer.\295\ In our judgment, the higher threshold 
will therefore provide greater certainty that the investor has some 
level of influence with the issuer. In addition, because issuers cannot 
necessarily prohibit a bad actor from establishing a large ownership 
position, particularly when an issuer's security is traded among non-
affiliates or in a secondary market, a higher threshold is expected to 
reduce the likelihood of a disqualifying event affecting an issuer in 
cases where a securityholder with a disqualifying bad act meets the 
beneficial ownership threshold in the rule but does not in fact 
exercise control or influence over the issuer. Lower uncertainty and 
relatively fewer ``covered persons'' arising from the amendment would 
reduce the costs of monitoring and due diligence for complying with the 
rule, and should limit the circumstances in which issuers must seek 
waivers from disqualification based on the involvement of bad actor 
investors that do not exercise influence or control over the issuer.
---------------------------------------------------------------------------

    \295\ It would also be in line with the level at which filing as 
a passive investor is no longer permitted on Schedule 13G under 
Regulation 13D-G. See 17 CFR 230.13d-1(c).
---------------------------------------------------------------------------

    At the same time, determining whether a securityholder is covered 
based on ownership of voting securities, calculating ownership based on 
voting power across all outstanding securities rather than a single 
class and raising the threshold from 10% to 20% could reduce investor 
protection benefits, as securityholders whose ownership does not meet 
the threshold provided in the final rule, but who exercise control of 
an issuer, would not be covered. The inclusion of directors, officers 
and their functional equivalents under the definition of covered 
persons, however, may mitigate this effect; the rule will cover 
investors who serve those functions in relation to the issuer, 
regardless of their level of ownership.
    With respect to 20% beneficial owners that are subject to 
triggering events, issuers may incur costs to buy out or otherwise 
induce such persons to reduce their ownership positions. Issuers may 
also incur costs in connection with taking steps to prevent bad actors 
from becoming 20% beneficial owners, such as exercising rights of first 
refusal and excluding bad actors from financing rounds. For certain 
issuers, finding investors to replace the capital represented by these 
shareholders or potential investors, as the case may be, could be 
challenging and expensive. Some commenters also expressed concerns 
about the aggregate costs of the proposed bad actor rule, saying that 
its provisions are generally unduly complex, unclear or not based on 
objective, bright-line standards.\296\ Others expressed concerns about 
the potential burdens on capital raising,\297\ and that it could 
undermine the overall utility of Rule 506.\298\
---------------------------------------------------------------------------

    \296\ See comment letters from ABA Fed. Reg. Comm.; NYCBA; 
Cleary Gottlieb.
    \297\ See comment letters from B. Nelson; Coy Capital; Five 
Firms; S&C.
    \298\ See Angel Capital Comment Letter 1; see also comment 
letters from ABA Fed. Reg. Comm.; Karr Tuttle; SIFMA; S&C.
---------------------------------------------------------------------------

    Issuers may also incur costs in connection with seeking waivers of 
disqualification from the Commission, or determinations by other 
authorities (such as state securities regulators) that their orders 
should not give rise to disqualification under Rule 506(d).
    The new disqualification standards may also impose costs on other 
market participants that are subject to triggering events, such as 
financial intermediaries, by making them ineligible to participate in 
the market for Rule 506 offerings. For affected individuals, this may 
result in demotion or termination of employment, limitations on career 
advancement and fewer employment opportunities generally. For affected 
firms, this may result in revenue reductions and loss of market share, 
and could threaten the continued operation of firms that are heavily 
dependent on Rule 506 offerings as a source of revenue. Firms that are 
not themselves disqualified but whose officers, directors, general 
partners and managing members are subject to disqualifying events may 
incur additional costs from terminating or reassigning such individuals 
and from hiring new personnel or retraining existing personnel to 
replace them.
    Bad actor disqualification rules may also impose costs on issuers 
and other market participants beyond the context of Rule 506 offerings. 
For example, imposing a new disqualification standard only on offerings 
under Rule 506, rather than on a more uniform basis, may result in 
higher costs for issuers relying on other exemptive rules, to the 
extent that differing disqualification standards create confusion and a 
more difficult compliance regime. Adopting uniform disqualification 
provisions throughout the Securities Act was cited by some commenters 
as a benefit, in that it could simplify compliance and increase overall 
investor protection.\299\
---------------------------------------------------------------------------

    \299\ See comment letters from ABA Fed. Reg. Comm.; C. Barnard; 
Better Markets; NASAA.
---------------------------------------------------------------------------

    In addition, non-uniform application of the new disqualification 
standards may encourage bad actors to migrate to offerings under other 
exemptions. Investors may perceive a higher risk of fraud in such 
offerings, which would be detrimental to their marketability and result 
in greater issuance costs of all offerings under the exemptions that 
are not subject to the new standards, whether or not bad actors are 
involved. This could have an effect on competition by putting issuers 
that are not eligible to use Rule 506 at a competitive disadvantage.
    Finally, there is a potential cost to investors of overreliance on 
Rule 506(d) in assessing the risks associated with an offering. Fraud 
can still occur without prior incidence of bad acting on the part of 
the issuer or covered persons, and in some cases it is possible that 
prior bad actions went undetected or did not otherwise result in a 
sanction, or may have resulted in a sanction that does not constitute a 
triggering event for disqualification.
2. Discretionary Amendments
    The amendments not specifically required under the Section 926 
mandate involve costs and benefits as analyzed below.
    Reasonable Care Exception. The ``reasonable care'' exception allows 
continued reliance on the Rule 506 exemption, despite the existence of 
a disqualification with respect to a covered person, if the issuer can 
show that it did not know and, in the exercise of reasonable care, 
could not have known that the disqualification existed at the time of 
the sale of securities. We anticipate that the ``reasonable care'' 
exception will provide benefits to the efficiency of the private 
placement and capital formation process by removing a significant 
disincentive to issuers' use of Rule 506 that would have arisen if 
disqualification were applied on a strict liability basis. Without a 
reasonable care exception, issuers might choose not to undertake 
offerings in reliance on Rule 506, because of the risk of Section 5 or 
blue sky law violations in circumstances that the issuer cannot 
reasonably predict or control. In those circumstances,

[[Page 44765]]

alternative approaches to capital raising may be more costly to the 
issuer or not available at all. Given that Rule 506 is the most 
frequently relied-upon Securities Act exemptive rule, the impact of 
issuers shifting away from it could be significant. We believe that the 
reasonable care exception provides a measured and balanced approach to 
preserve the intended benefits of Rule 506, which might otherwise be 
impaired because of issuer concerns about strict liability for unknown 
disqualifications.
    Commenters uniformly supported the reasonable care exception, but 
also urged the Commission to provide greater clarity and specificity 
about what steps would constitute reasonable care. Some commenters 
raised concerns about compliance costs if the requirements of the 
``reasonable care'' exception are too burdensome.\300\ We do not 
believe it is appropriate to delineate and prescribe specific steps as 
being necessary or sufficient to establish reasonable care. We believe 
issuers should consider the totality of the offering taking into 
account the circumstances of the offering, the covered persons involved 
in the offering and the rule's requirements, which include specific 
disqualifying events and covered persons subject to those disqualifying 
events. The flexibility in permitting issuers to determine their own 
methodology for factual inquiry is a benefit that promotes efficiency 
to the extent the issuer is able to tailor its own inquiry without 
adherence to uniform standards that may not be applicable or 
appropriate in the context of a particular issuer or particular 
offering.
---------------------------------------------------------------------------

    \300\ See Angel Capital Comment Letter 1; see also comment 
letter from S&C.
---------------------------------------------------------------------------

    A potential cost of a reasonable care exception is that it may 
increase the likelihood that bad actors will be able to participate in 
Rule 506 offerings, because issuers may take fewer steps to make 
inquiry about offering participants than they would if a strict 
liability standard applied. If this occurs, it will decrease the 
deterrent effect of the bad actor disqualification rules. To the extent 
that the reasonable care exception fails to prevent participation by 
bad actors in Rule 506 offerings, the effectiveness of the new 
disqualification standard will be impaired.
    Issuers may also incur costs associated with conducting and 
documenting their factual inquiry into possible disqualifications, so 
they can demonstrate the exercise of reasonable care. The fact that the 
rule does not specify what steps are required may increase such costs 
to the extent that issuers do more to conduct and document their 
inquiry than otherwise may be necessary, because of this uncertainty.
    Disclosure Requirement for Triggering Events That Predate the 
Effectiveness of the Rule Amendments. As adopted, the amendments 
include a disclosure requirement designed to increase investor 
protection by requiring disclosure of events that would have been 
disqualifying had they occurred after the effective date of the 
amendments. This is a change from the proposal, under which 
disqualification would have arisen with respect to events that occurred 
before the amendments took effect.
    Under the amendments we are adopting, issuers will be subject to 
disqualification only for triggering events that occur after the new 
rules take effect. On one hand, this approach will reduce costs that 
would otherwise have been incurred by issuers and other market 
participants subject to pre-existing triggering events, had they been 
disqualified from participating in Rule 506 offerings. On the other 
hand, this approach will permit offerings involving past bad actors to 
proceed under Rule 506, exposing investors to the risks that arise when 
bad actors are associated with an offering. While it is difficult to 
determine the net impact of implementing the new disqualification 
standards in this way, investors will benefit by having access to 
information about events that would be disqualifying if they had 
occurred after the effective date. Investors will be able to make their 
own determination of the relevance and risks associated with past bad 
acts, including recidivism risk, and can request additional 
information, elect not to pursue the investment opportunity or 
negotiate different terms based on this information.
    We anticipate that the decision to require disclosure will provide 
a benefit to issuers and investors. We believe the disclosure 
requirement will serve as a useful tool to alert investors to the 
presence of certain participants in offerings under Rule 506 and allow 
them to make more informed investment decisions. Without a disclosure 
requirement, investors may have the mistaken impression that bad actors 
are no longer allowed to participate in Rule 506 offerings. As there is 
no prescribed format, the disclosure could be inserted in a non-
prominent manner, such that an investor who reads the material in a 
cursory fashion could remain unaware of the participation of bad actors 
in the offering. Issuers could benefit from having flexibility in the 
manner of disclosure. In addition, because we have imposed a disclosure 
requirement rather than disqualification for pre-existing events, 
issuers will not be required to revisit past negotiated settlements or 
incur additional costs to request waivers for disqualification. Issuers 
will, however, incur costs in connection with the factual inquiry to 
determine whether disclosure is required and, if applicable, in 
preparing the mandatory disclosure for investors, which we have 
described in Section III above. Also, rather than provide the mandatory 
disclosure, we expect some issuers may decide to take steps to avoid 
having to make a disclosure, such as making changes to personnel or 
retaining different compensated solicitors, and in that respect may 
incur costs similar to those associated with avoiding or removing a 
potential disqualification.
    We also recognize that issuers that disclose triggering events may 
have greater difficulty attracting investors to their offerings and may 
incur a higher cost of capital as a result. We do not have data with 
respect to current issuer practices involving disclosure of the 
participation of persons with a history of regulatory or other legal 
sanctions for securities law violations and, as such, we are unable to 
determine the extent to which the disclosure requirement will impact 
issuers' cost of capital. If investors are unwilling to participate in 
offerings involving prior bad actors, some issuers and other market 
participants will, as a practical matter, be excluded from the Rule 506 
market and will experience some or all of the impact of 
disqualification.
    Commission Cease-and-Desist Orders Involving Scienter-Based Anti-
Fraud Violations and Violations of Securities Act Section 5. Under the 
rule amendments we adopt today, disqualification will be triggered by 
Commission cease-and-desist orders based on violations of scienter-
based anti-fraud provisions of the federal securities laws or Section 5 
of the Securities Act. The addition of these categories of Commission 
orders as a new triggering event is intended to provide a benefit to 
investors by screening out additional bad actors, while reducing the 
risk that disqualification would be imposed on securities law violators 
who do not pose a significant investor protection concern.
    We believe the investor protection benefits of adding Commission 
cease-and-desist orders to the disqualification provisions of Rule 506 
justify the potential costs to issuers and other covered persons. The 
benefits associated with screening bad actors out of the Rule 506 
market should not depend on

[[Page 44766]]

whether a particular enforcement action is brought in court or through 
a Commission administrative proceeding. Clearly, the absence of 
Commission cease-and-desist orders from an investor protection rule 
that includes federal judicial proceedings addressing the same legal 
violations, and orders by state and other federal regulators addressing 
the same conduct, would lead to asymmetry in the administration of 
disqualification under Rule 506. We also do not believe that the 
addition of Commission cease-and-desist orders is likely to impose a 
significant cost to issuers and other covered persons because these 
groups may already be subject to other disqualifying orders issued by 
the states, federal banking regulators and the National Credit Union 
Administration.
    It is difficult to predict the extent to which adding these 
Commission cease-and-desist orders to the list of disqualifying events 
will increase the number of bad actors subject to disqualification from 
Rule 506 offerings. In our analysis of disqualifying events from 2007 
through 2011 discussed earlier, we attempted to assess the number of 
individuals or entities that would be disqualified as bad actors based 
solely on Commission cease-and-desist orders described in subsection 
(v) of Rule 506(d)(1). We identified 116 cease-and-desist orders 
against respondents that were not otherwise subject to a disqualifying 
injunction, disciplinary order or felony conviction during the 2007 to 
2011 period.\301\ To the extent that these historical levels project 
future levels of disqualifying Commission cease-and-desist orders, we 
estimate that on an annual basis, there may be approximately 23 
individuals or entities disqualified by cease-and-desist orders and not 
also by some other triggering event. To provide a context, there were 
in excess of 83,521 Rule 506 offerings during the period 2007-2011. 
With 116 cease and desist orders during the same period, the potential 
disqualification incidence created by Commission cease-and-desist 
orders would appear to be quite low (using these inputs, less than 
0.15%).
---------------------------------------------------------------------------

    \301\ As there is no comprehensive database of triggering 
events, the analysis included a review of litigation releases and 
other documentation for information on other events that would have 
disqualified these respondents. Some of these documents provided 
short disciplinary histories, but they are not comprehensive and in 
any case would not capture subsequent triggering events.
---------------------------------------------------------------------------

    In addition, inclusion of Commission cease-and-desist orders as a 
triggering event for bad actor disqualification may change how 
settlement negotiations are conducted between respondents and the 
Commission. Even after the Commission imposes a disqualifying cease-
and-desist order upon a covered person, the Commission may grant an 
appropriate waiver from disqualification based on settlement 
negotiations or other remedial measures and steps taken by the covered 
person to comply with the Commission cease-and-desist order. We believe 
that issuers and other covered persons will be able to consider the 
practical consequences of a future Commission cease-and-desist order 
and alter their conduct to avoid committing the behavior causing the 
violation. Alternatively, they can seek to obtain a waiver of 
disqualification in enforcement settlement negotiations.
    We anticipate that this additional triggering event will add 
minimal incremental costs for issuers, given the requirement in the 
rule as adopted to conduct factual inquiry to determine whether the 
offering is subject to bad actor disqualification. To the extent that 
the addition of a disqualifying event broadens the type and the number 
of covered persons who will be disqualified from participation in Rule 
506 offerings, it may have a detrimental effect on capital raising 
activity by delaying or deterring offerings, or causing issuers to 
incur higher transaction costs.
    CFTC Orders. Under the rule amendments we adopt today, 
disqualification will be triggered by orders issued by the CFTC to the 
same extent as orders of the regulators enumerated in Section 926 of 
the Dodd-Frank Act (e.g., state securities, insurance and banking 
regulators, federal banking agencies and the National Credit Union 
Administration). We believe that including orders of the CFTC will 
result in the treatment of comparable sanctions similarly for 
disqualification purposes, and should enable the disqualification rules 
to more effectively screen out felons and bad actors. We note in that 
regard that 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. 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.
    We have a limited ability to quantify the impact of including CFTC 
orders as a new disqualification trigger under Rule 506(d). While we 
have access to general information about CFTC enforcement 
activity,\302\ we have no systematic way to filter CFTC orders for 
connection to Rule 506 offerings or private placements or to isolate 
situations in which a participant in a Rule 506 offering would be 
subject to disqualification solely on the basis of a CFTC order. While 
registered broker-dealers are required to report CFTC proceedings and 
orders on Form BD, we have no systematic way to filter Form BD data on 
that basis or to identify registered broker-dealers that are likely to 
participate in Rule 506 offerings or private placements.
---------------------------------------------------------------------------

    \302\ See e.g., Commodity Futures Trading Commission Annual 
Performance Report, Fiscal Year 2012 at Appendix A (available here: 
http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/2012apr.pdf.) A summary of CFTC enforcement proceedings from 2005 
through 2008 is available here: http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/file/pbproceedingsbulletin.pdf.
---------------------------------------------------------------------------

    We were able to review disclosures concerning CFTC orders on Form 
ADV by registered investment advisers and exempt reporting advisers 
with pooled investment fund clients. In on our review of 384 Forms ADV 
(as described in detail below), we found six investment adviser firms 
associated with pooled investment funds that were subject to CFTC 
orders that would constitute triggering events under Rule 506(d).
    Definition of ``final order.'' The change in the definition of 
``final order'' limiting it to orders under statutory authority that 
provides for notice and an opportunity for hearing should have marginal 
economic impact for issuers. We do not believe that the incremental 
burden of inquiry to determine whether an order was issued under such 
authority will have a significant impact. The change could have the 
effect of reducing the number of disqualifying events for which issuers 
or other market participants might seek waivers which, in cases where 
the waiver would have been granted, would reduce costs and could 
facilitate capital formation. The economic impact on investors from 
this change will depend primarily on the extent to which the additional 
procedural requirement results in bad actors that would otherwise be 
disqualified remaining eligible to participate in Rule 506 offerings, 
and the recidivism rates of those bad actors.
    Investment Managers. Under the rule amendments we adopt today, 
investment managers of issuers that are pooled investment funds (that 
is, investment advisers of pooled investment funds and persons who 
provide similar investment advisory

[[Page 44767]]

services to pooled investment funds with respect to assets other than 
securities) have been added as a new category of covered person. We 
believe that this approach will reduce compliance costs, in that it 
represents a ``bright-line'' category of presumed control persons based 
on governance and control structures that are typical for pooled 
investment fund issuers, replacing a potentially costly fact-intensive 
inquiry into whether such persons should be deemed the equivalent of 
``directors'' or ``executive officers'' of an issuer organized in 
corporate form. The addition of this new category facilitates 
equivalent treatment of operating companies and pooled investment funds 
under new Rule 506(d).
    Incidence of Bad Actors Among Investment Advisers.
i. Analysis of Triggering Events Based on Enforcement Actions Initiated 
by the Commission
    In the review described above in Section IV.B.3, we found that 47 
of the random sample of 529 identified cases involved investment 
advisers (18 of these 47 were also broker-dealers). None of these 47 
investment advisers was sanctioned in connection with a private 
offering. This, however, would represent only a lower bound for the 
incidence of bad actor triggering events among investment advisers, as 
the analysis was based on a random sample drawn from the legal 
proceedings that were brought before the Commission during the period 
2007-2011. In addition, our analysis does not take into account bad 
actor triggering events other than those in subsections (ii), (iv), and 
(v) of Rule 506(d)(1) or offerings involving bad actors that did not 
give rise to enforcement activity.
ii. Form ADV Data
    We analyzed all Form ADVs filed by investment advisers for 2012 to 
determine the reported incidence of disqualification triggering events. 
We limited our review to forms filed by investment advisers that:
     Advise a private fund or have clients that are registered 
investment companies, business development companies or other pooled 
investment vehicles;
     Provided disclosure reporting pages on their current Form 
ADV; and
     Indicated that some of the disclosure reporting pages are 
for the adviser itself or its supervised persons.

We considered only orders whose status was reported as final. Based on 
these criteria, we identified 384 investment advisers that disclosed 
matters that may have constituted a triggering event under Rule 506(d).
    Looking at the cases and the regulatory and court actions involved, 
we determined whether the reported sanctions would constitute 
triggering events under Rule 506(d). Most of the sanctions would not 
because the criteria for providing disclosure reporting pages for Form 
ADV include many events that do not constitute bad actor triggering 
events under new Rule 506(d). For example, we excluded cases that were 
initiated by a foreign court or regulator, cases that involved an 
affiliate firm or cases that involved an individual employee of an 
affiliate who is not a control person in the parent advisory firm. We 
also excluded cases where a sanction fell outside the relevant look-
back period, such as a Commission cease-and-desist order that is more 
than five years old. In addition, we excluded cases in which an action 
did not meet the relevant substantive criteria, such as Commission 
cease-and-desist orders for violations other than Section 5 of the 
Securities Act or a scienter-based anti-fraud provision, or felonies 
that were unrelated to the criteria of Rule 506(d), such as traffic 
violations.
    After these exclusions, we found that approximately 1% of reporting 
investment advisers associated with pooled investment funds reported 
bad actor triggering events in their 2012 Form ADV. The results of our 
analysis are presented in the table below.\303\
---------------------------------------------------------------------------

    \303\ Note that since an investment adviser can be subject a 
combination of criminal, regulatory and civil sanctions, the sum of 
the three categories of sanctions may exceed the number of 
investment advisers that are subject to sanctions.

------------------------------------------------------------------------
                                                               Number of
                                                              investment
                                                               advisers
------------------------------------------------------------------------
Total investment advisers...................................      13,173
Investment advisers advising pooled investment funds........       7,772
Pooled investment fund investment advisers with disclosure           435
 reporting pages............................................
Pooled investment fund investment advisers subject to final          384
 orders.....................................................
Pooled investment fund investment advisers with `bad actor'           48
 triggering events..........................................
Criminal sanctions..........................................           1
Regulatory sanctions........................................          42
Civil sanctions.............................................          11
------------------------------------------------------------------------

    Analysis of Costs and Benefits. Investment managers play a 
significant role in the management of pooled investment funds. We have 
included them in the definition of covered persons so that entities or 
individuals that exercise control over fund management are subject to 
bad actor disqualification under Rule 506(d). It will therefore provide 
consistency for covering `control persons' of both pooled investment 
fund issuers and issuers that are not pooled investment funds.
    Additional issuer costs arising from the addition of investment 
managers as covered persons will arise from conducting factual 
inquiries and, in some cases, restructuring governance and control 
arrangements, preparing disclosure or obtaining waivers from 
disqualification for having an investment adviser with a history of bad 
acting. Our analysis shows that the incidence of disqualifying events 
is low (less than 1%) for investment advisers. So their inclusion in 
the list of covered persons should not be generally burdensome for 
issuers. On the other hand, covering investment managers directly will 
obviate the need for issuers to conduct a fact-intensive inquiry to 
determine whether an investment manager would be regarded as a de facto 
director or executive officer of a pooled investment fund, or as a 
promoter of such fund. As a result, the additional costs from this new 
category of covered person are not likely to be high.
    Narrower Coverage of Officers of Issuers and Financial 
Intermediaries. Some commenters raised concerns that the compliance 
costs associated with monitoring a potentially large class of covered 
persons may be high.\304\ The rules we are adopting limit the pool of 
covered persons by covering only executive officers and officers 
participating in the offering, rather than all officers, of issuers, 
underwriters, compensated solicitors and investment managers of pooled 
investment funds. This should reduce compliance costs by limiting 
covered persons to a more manageable number who should generally be 
easier to identify. It should also reduce or eliminate costs, such as 
lost employment opportunities, for individuals who are subject to 
potentially disqualifying events but are not executive officers of 
issuers, compensated solicitors or investment managers to pooled 
investment fund issuers and are not personally involved in Rule 506 
offerings. We do not believe it will significantly compromise the 
intended investor protection benefits of the rule, because all officers 
performing policy-making functions or personally involved with the 
offering will be covered.
---------------------------------------------------------------------------

    \304\ See comment letters from SIFMA; NYCBA; Five Firms; S&C.
---------------------------------------------------------------------------

    No Disqualification Where the Relevant Regulatory Authority Advises

[[Page 44768]]

That Disqualification is Not Warranted. The amendments we are adopting 
include a provision under which disqualification will not arise if a 
state or federal regulator issuing an order advises in writing that 
Rule 506 disqualification is not necessary under the circumstances. We 
believe this provision will create cost savings for affected covered 
persons such as issuers, individuals and compensated solicitors by 
eliminating the need to seek waivers from the Commission or pursue 
other means of raising capital. We expect that some issuers and other 
covered persons will adjust their settlement negotiations to bargain 
for an express determination that disqualification from Rule 506 is 
unnecessary.\305\ As the provision applies only where state or federal 
regulators have determined that Rule 506 disqualification is not 
necessary, we do not believe it is likely to impair the intended 
investor protection benefits of the bad actor disqualification scheme.
---------------------------------------------------------------------------

    \305\ See Rule 506(d)(2)(iii).
---------------------------------------------------------------------------

V. Final Regulatory Flexibility Act Analysis

    This final regulatory flexibility analysis has been prepared in 
accordance with 5 U.S.C. 603. It relates to amendments to Rule 506 of 
Regulation D under the Securities Act that disqualify certain offerings 
where ``felons and other `bad actors''' are participating or present 
from relying on Rule 506 for an exemption from registration under the 
Securities Act, or impose disclosure requirements in respect of such 
offerings.

A. Reasons for, and Objectives of, the Action

    The primary reason for the amendments is to implement the 
requirements of Section 926 of the Dodd-Frank Act. Section 926 requires 
the Commission to issue rules under which certain offerings where 
``felons and other `bad actors''' are participating or present will be 
disqualified from reliance on Rule 506 under Regulation D for an 
exemption from registration under the Securities Act. Under the 
amendments adopted today, offerings will be disqualified for triggering 
events that occur after the effective date of the amendments, and 
disclosure to investors will be required in respect of triggering 
events that occur before the effective date.
    Our primary objective is to implement the requirements of Section 
926 of the Dodd-Frank Act. In general, the rule we are adopting 
implements the statutory requirements. We have included a ``reasonable 
care'' exception in the final amendments, which we believe will make 
the rule easier for issuers to use, and should encourage continued use 
of Rule 506 over exempt transactions outside of Rule 506. We have also 
added an additional disqualifying event for certain Commission cease-
and-desist orders, which we believe will make the overall regulatory 
scheme more consistent and will increase the investor protection 
benefits of the amendments. We are requiring disclosure, rather than 
disqualification, for triggering events occurring before effectiveness 
of the final amendments as a means of enhancing protection of investors 
participating in offerings involving bad actors, without giving rise to 
the fairness and other concerns associated with applying the new 
disqualification provisions in respect of preexisting events.

B. Significant Issues Raised by Public Comment

    In the proposing release, we requested comment on every aspect of 
the initial regulatory flexibility analysis (``IRFA''), including the 
number of small entities that would be affected by the proposed 
amendments, the nature of the impact, how to quantify the number of 
small entities that would be affected, and how to quantify the impact 
of the proposed amendments. We did not receive comments specifically 
addressing the IRFA. One commenter suggested exempting offerings below 
a certain size from the new disqualification provisions based on 
concerns about the cost of Securities Act registration if Rule 506 were 
unavailable,\306\ but we do not believe that would be consistent with 
the requirements of Section 926 of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \306\ See comment letter from Burningham.
---------------------------------------------------------------------------

C. Small Entities Subject to the Rule Amendments

    The amendments will affect issuers (including both operating 
businesses and investment funds that raise capital under Rule 506) and 
other covered persons, such as financial intermediaries, that are small 
entities. For purposes of the Regulatory Flexibility Act under our 
rules, an entity is a ``small business'' or ``small organization'' if 
it has total assets of $5 million or less as of the end of its most 
recent fiscal year and is engaged or proposing to engage in an offering 
of securities that does not exceed $5 million.\307\ For purposes of the 
Regulatory Flexibility Act, an investment company is a small entity if 
it, together with other investment companies in the same group of 
related investment companies, has net assets of $50 million or less as 
of the end of its most recent fiscal year.
---------------------------------------------------------------------------

    \307\ 17 CFR 230.157.
---------------------------------------------------------------------------

    The final amendments will apply to all issuers that conduct 
offerings under Rule 506 and will affect small issuers (including both 
operating businesses and pooled investment funds that raise capital 
under Rule 506) relying on this exemption from Securities Act 
registration. All issuers that sell securities in reliance on 
Regulation D are required to file a Form D with the Commission 
reporting the transaction. For the year ended December 31, 2012, 16,067 
issuers made 18,187 new Form D filings, of which 15,208 relied on the 
Rule 506 exemption. Based on information reported by issuers on Form D, 
there were 3,958 small issuers \308\ relying on the Rule 506 exemption 
in 2012. This number likely underestimates the actual number of small 
issuers relying on the Rule 506 exemption, however, because over 50% of 
issuers declined to report their size.
---------------------------------------------------------------------------

    \308\ Of this number, 3,627 of these issuers are not investment 
companies, and 331 are investment companies. We also note that 
issuers that are not investment companies disclose only revenues on 
Form D, and not total assets. Hence, we use the amount of revenues 
as a measure of issuer size.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping and Other Compliance Requirements

    The final amendments will impose a disclosure requirement with 
respect to triggering events that occurred before the effective date of 
the new disqualification provisions and would have triggered 
disqualification had they occurred after that date.\309\ Such 
disclosure must be in writing and furnished to each purchaser a 
reasonable time prior to sale. There is no prescribed form that such 
disclosure must take.
---------------------------------------------------------------------------

    \309\ As discussed in Part II.G of this Release, we are also 
changing the form of the signature block of Form D.
---------------------------------------------------------------------------

    In addition, we expect that issuers will exercise reasonable care 
to ascertain whether a disqualification exists with respect to any 
covered person, and document their exercise of reasonable care. The 
steps required will vary with the circumstances, but we anticipate 
would generally include making factual inquiry of covered persons and, 
where the issuer has reason to question the veracity or completeness of 
responses to such inquiries, further steps such as reviewing 
information on publicly available databases. In addition, issuers will 
have to prepare any necessary disclosure regarding preexisting events.

[[Page 44769]]

We expect that the costs of compliance would generally be lower for 
small entities than for larger ones because of the relative simplicity 
of their organizational structures and securities offerings and the 
generally smaller numbers of individuals and entities involved.

E. Duplicative, Overlapping or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate, 
overlap or conflict with the final amendments to Rules 145, 147, 152 
and 155; Rules 501 and 506 of Regulation D; and Form D under the 
Securities Act and to Rule 30-1 of our Rules of Organization and 
Program Management.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish the stated objectives of our 
amendments, while minimizing any significant adverse impact on small 
entities. In connection with the final amendments, we considered the 
following alternatives:
     The establishment of different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities;
     The clarification, consolidation, or simplification of the 
rule's compliance and reporting requirements for small entities;
     The use of performance rather than design standards; and
     An exemption from coverage of the amendments, or any part 
thereof, for small entities.
    With respect to the establishment of different compliance 
requirements or timetables under our final amendments for small 
entities, we do not think this is feasible or appropriate. The 
amendments are designed to exclude ``felons and other `bad actors' '' 
from involvement in Rule 506 securities offerings, which could benefit 
small issuers by protecting them and their investors from bad actors 
and increasing investor trust in such offerings. Increased investor 
trust could reduce the cost of capital and create greater opportunities 
for small businesses to raise capital.
    Likewise, with respect to potentially clarifying, consolidating, or 
simplifying compliance and reporting requirements, the amendments do 
not impose any new reporting requirements. To the extent they may be 
considered to create a new compliance requirement to exercise 
reasonable care to ascertain whether a disqualification exists with 
respect to any offering and to furnish a written description of 
preexisting triggering events, the precise steps necessary to meet that 
requirement will vary according to the circumstances. In general, we 
believe the requirement will more easily be met by small entities than 
by larger ones because we believe that their structures and securities 
offerings are generally less complex and involve fewer participants.
    With respect to using performance rather than design standards, we 
note that the ``reasonable care'' exception is a performance standard.
    With respect to exempting small entities from coverage of these 
final amendments, we believe such an approach would be impracticable 
and contrary to the requirements of Section 926. Regulation D was 
designed, in part, to provide exemptive relief for smaller issuers. 
Exempting small entities from bad actor provisions could result in a 
decrease in investor protection and trust in the private placement and 
small offerings markets, which would be contrary to the legislative 
intent of Section 926. We have endeavored to minimize the regulatory 
burden on all issuers, including small entities, while meeting our 
regulatory objectives, and have included a ``reasonable care'' 
exception and waiver authority for the Commission to give issuers and 
other covered persons additional flexibility with respect to the 
application of these amendments.

VI. Statutory Authority and Text of Amendments

    We are adopting the amendments to 17 CFR Parts 230 and 239 
contained in this document under the authority set forth in Sections 
4(a)(2), 19 and 28 of the Securities Act, as amended,\310\ and Section 
926 of the Dodd-Frank Act.\311\ We are adopting the amendments to 17 
CFR Part 200 contained in this document under the authority of Sections 
4A and 4B of the Securities Exchange Act of 1934.\312\
---------------------------------------------------------------------------

    \310\ 15 U.S.C. 77d(a)(2), 77s and 77z-3.
    \311\ 15 U.S.C. 77d note. Although Pub. L. No. 112-106, sec. 
201(a), 126 Stat. 313 (2012) is not an authority for the amendments 
in this release, it is being included in the instruction below for 
the general authority citation for Part 230 to ensure that the Code 
of Federal Regulations is correctly updated for purposes of the 
final rule also published today.
    \312\ 15 U.S.C. 78d-1, 78d-2.
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations 
(Government agencies), Organization and functions (Government 
agencies), Reporting and recordkeeping requirements.

17 CFR Parts 230 and 239

    Reporting and recordkeeping requirements, Securities.

    For the reasons set out above, Title 17, Chapter II of the Code of 
Federal Regulations is hereby amended as follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND 
REQUESTS

0
1. The general authority citation for Part 200, Subpart A, continues to 
read, in part, as follows and the sectional authority for Sec.  200.312 
is removed.

    Authority:  15 U.S.C. 77o, 77s, 77sss, 78d, 78d-1, 78d-2, 78w, 
78ll (d), 78mm, 80a-37, 80b-11, and 7202, unless otherwise noted.
* * * * *

0
2. Section 200.30-1(c) is revised to read as follows:


Sec.  200.30-1  Delegation of authority to Director of Division of 
Corporation Finance.

* * * * *
    (c) With respect to the Securities Act of 1933 (15 U.S.C. 77a et 
seq.) and Regulation D thereunder (Sec. Sec.  230.500 through 230.508 
of this chapter), to authorize the granting of applications under 
Sec. Sec.  230.505(b)(2)(iii)(C), 230.506(d)(2)(ii), and 230.507(b) of 
this chapter upon the showing of good cause that it is not necessary 
under the circumstances that the exemption under Regulation D be 
denied.
* * * * *

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
3. The general authority citation for Part 230 is revised to read as 
follows:

    Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77d note, 77f, 
77g, 77h, 77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 
78o, 78o-7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 
80a-29, 80a-30, and 80a-37, and Pub. L. No. 112-106, Sec.  201(a), 
126 Stat. 313 (2012), unless otherwise noted.
* * * * *

0
4. Amend Sec.  230.145 by:
0
a. Removing the reference to ``and 4(2)'' in the second paragraph of 
the Preliminary Note and adding in its place ``and 4(a)(2)'';
0
b. Removing Note 1 and Note 2 following the introductory text; and
0
c. Revising the introductory text following the Preliminary Note to 
read as follows:


Sec.  230.145  Reclassification of securities, mergers, consolidations 
and acquisitions of assets.

* * * * *

[[Page 44770]]

    Transactions for which statutory exemptions under the Act, 
including those contained in sections 3(a)(9), (10), (11) and 4(2), are 
otherwise available are not affected by Rule 145. Reference is made to 
Rule 153a (Sec.  230.153a of this chapter) describing the prospectus 
delivery required in a transaction of the type referred to in Rule 145. 
A reclassification of securities covered by Rule 145 would be exempt 
from registration pursuant to section 3(a)(9) or (11) of the Act if the 
conditions of either of these sections are satisfied.
* * * * *

0
5. Amend Sec.  230.147(b)(2) by removing the reference to ``section 
4(2)'' and adding in its place ``section 4(a)(2)''.
0
6. Amend Sec.  230.152 by removing the reference to ``section 4(2)'' 
and adding in its place ``section 4(a)(2)''.

0
7. Amend Sec.  230.155 by removing the phrase ``Preliminary Note:'' and 
redesignating that note as the introductory text, and removing the 
reference to ``section 4(2)'' from paragraph (a) and adding in its 
place ``section 4(a)(2)''.

0
8. Amend Sec.  230.501 by:
0
a. Redesignating paragraphs (g) and (h) as paragraphs (h) and (i), 
respectively, and adding new paragraph (g); and
0
b. Redesignating Notes 1, 2, and 3 at the end of the section as Note 1 
to Sec.  230.501, Note 2 to Sec.  230.501, and Note 3 to Sec.  230.501, 
respectively.
    The addition reads as follows:


Sec.  230.501  Definitions and terms used in Regulation D.

* * * * *
    (g) Final order. Final order shall mean a written directive or 
declaratory statement issued by a federal or state agency described in 
Sec.  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.
* * * * *

0
9. Amend Sec.  230.506 by:
0
a. Redesignating the Note following paragraph (b)(2)(i) as ``Note to 
paragraph (b)(2)(i)'';
0
b. Adding and reserving paragraph (c); and
0
c. Adding paragraphs (d) and (e).
    The additions read as follows:


Sec.  230.506  Exemption for limited offers and sales without regard to 
dollar amount of offering.

* * * * *
    (c) [Reserved]
    (d) ``Bad Actor'' disqualification. (1) No exemption under this 
section shall be available for a sale of securities if the issuer; any 
predecessor of the issuer; any 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 promoter connected with 
the issuer in any capacity at the time of such sale; any investment 
manager of an issuer that is a pooled investment fund; any person that 
has been or will be paid (directly or indirectly) remuneration for 
solicitation of purchasers in connection with such sale of securities; 
any general partner or managing member of any such investment manager 
or solicitor; or any director, executive officer or other officer 
participating in the offering of any such investment manager or 
solicitor or general partner or managing member of such investment 
manager or solicitor:
    (i) 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:
    (A) In connection with the purchase or sale of any security;
    (B) Involving the making of any false filing with the Commission; 
or
    (C) 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;
    (ii) Is subject to 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:
    (A) In connection with the purchase or sale of any security;
    (B) Involving the making of any false filing with the Commission; 
or
    (C) 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;
    (iii) 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:
    (A) At the time of such sale, bars the person from:
    (1) Association with an entity regulated by such commission, 
authority, agency, or officer;
    (2) Engaging in the business of securities, insurance or banking; 
or
    (3) Engaging in savings association or credit union activities; or
    (B) 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;
    (iv) Is subject to an order of the Commission entered pursuant to 
section 15(b) or 15B(c) of the Securities Exchange Act of 1934 (15 
U.S.C. 78o(b) or 78o-4(c)) or section 203(e) or (f) of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-3(e) or (f)) that, at the time of 
such sale:
    (A) Suspends or revokes such person's registration as a broker, 
dealer, municipal securities dealer or investment adviser;
    (B) Places limitations on the activities, functions or operations 
of such person; or
    (C) Bars such person from being associated with any entity or from 
participating in the offering of any penny stock;
    (v) 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:
    (A) Any scienter-based anti-fraud provision of the federal 
securities laws, including without limitation section 17(a)(1) of the 
Securities Act of 1933 (15 U.S.C. 77q(a)(1)), section 10(b) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78j(b)) and 17 CFR 240.10b-
5, section 15(c)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 
78o(c)(1)) and section 206(1) of the Investment Advisers Act of 1940 
(15 U.S.C. 80b-6(1)), or any other rule or regulation thereunder; or
    (B) Section 5 of the Securities Act of 1933 (15 U.S.C. 77e).
    (vi) 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;
    (vii) 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,

[[Page 44771]]

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; or
    (viii) 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.
    (2) Paragraph (d)(1) of this section shall not apply:
    (i) With respect to any conviction, order, judgment, decree, 
suspension, expulsion or bar that occurred or was issued before 
September 23, 2013;
    (ii) Upon a showing of good cause and without prejudice to any 
other action by the Commission, if the Commission determines that it is 
not necessary under the circumstances that an exemption be denied;
    (iii) If, before the relevant sale, the court or regulatory 
authority that entered the relevant order, judgment or decree advises 
in writing (whether contained in the relevant judgment, order or decree 
or separately to the Commission or its staff) that disqualification 
under paragraph (d)(1) of this section should not arise as a 
consequence of such order, judgment or decree; or
    (iv) If the issuer establishes that it did not know and, in the 
exercise of reasonable care, could not have known that a 
disqualification existed under paragraph (d)(1) of this section.
    Instruction to paragraph (d)(2)(iv). An issuer will not be able to 
establish that it has exercised reasonable care unless it has made, in 
light of the circumstances, factual inquiry into whether any 
disqualifications exist. The nature and scope of the factual inquiry 
will vary based on the facts and circumstances concerning, among other 
things, the issuer and the other offering participants.
    (3) For purposes of paragraph (d)(1) of this section, events 
relating to any affiliated issuer that occurred before the affiliation 
arose will be not considered disqualifying if the affiliated entity is 
not:
    (i) In control of the issuer; or
    (ii) Under common control with the issuer by a third party that was 
in control of the affiliated entity at the time of such events.
    (e) Disclosure of prior ``bad actor'' events. The issuer shall 
furnish to each purchaser, a reasonable time prior to sale, a 
description in writing of any matters that would have triggered 
disqualification under paragraph (d)(1) of this section but occurred 
before September 23, 2013. The failure to furnish such information 
timely shall not prevent an issuer from relying on this section if the 
issuer establishes that it did not know and, in the exercise of 
reasonable care, could not have known of the existence of the 
undisclosed matter or matters.
    Instruction to paragraph (e). An issuer will not be able to 
establish that it has exercised reasonable care unless it has made, in 
light of the circumstances, factual inquiry into whether any 
disqualifications exist. The nature and scope of the factual inquiry 
will vary based on the facts and circumstances concerning, among other 
things, the issuer and the other offering participants.

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
10. The authority citation for part 239 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78ll, 
78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 
80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *

0
11. Amend Form D (referenced in Sec.  239.500) by revising the third 
indented paragraph under the heading ``Terms of Submission'' in the 
``Signature and Submission'' section following Item 16 to read as 
follows:
    Certifying that, if the issuer is claiming a Regulation D exemption 
for the offering, the issuer is not disqualified from relying on 
Regulation D for one of the reasons stated in Rule 505(b)(2)(iii) or 
Rule 506(d).

    Note: The text of Form D does not, and the amendments will not, 
appear in the Code of Federal Regulations.


    By the Commission.

     Dated: July 10, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-16983 Filed 7-23-13; 8:45 am]
BILLING CODE 8010-01-P


