The SEC has proposed a rule that would disqualify securities offerings involving certain “felons and other ‘bad actors’” from reliance on the safe harbor from Securities Act registration provided by Rule 506 of Regulation D. The rule change is required by Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Rule 506 is the most common Regulation D exemption used for private placements. The current version of the rule does not disqualify so-called “bad boys,” and state-level bad actor disqualifications do not apply because securities sold under Rule 506 are “covered securities.”

Under the proposed rule, directors, officers, and significant shareholders, among others, would not be able to participate in securities offerings exempt under Rule 506 if such individuals are subject to convictions, injunctions, and other administrative orders in connection with securities offerings.

Issuers thinking about a 506 offering should consider requiring directors, officers, and promoters to complete a questionnaire designed to elicit information that could trigger a “bad boy” provision. The proposed rule does not require such a questionnaire but does propose a “reasonable care” exception, under which an issuer would not lose the benefit of the Rule 506 safe harbor, despite the existence of a disqualifying event, if it can show that it did not know and, in the exercise of reasonable care, could not have known of the disqualification. The rule release provides that to establish reasonable care, the issuer would be expected to conduct a factual inquiry, the nature and extent of which would depend on the facts and circumstances of the situation.