Understanding the intricacies of securities regulations can be daunting, especially when navigating the nuances of Regulation D and its various rules. This article dives deep into Rule 506(d), focusing specifically on subsections (d)(2)(ii), (d)(2)(iii), and (d)(3). We'll break down each rule, explore their differences, and highlight their implications for businesses looking to raise capital. Whether you're a seasoned investor or just starting, this guide will provide clarity on these critical aspects of securities law. So, let's get started and demystify these regulations together!

Understanding Regulation D and Rule 506

Before we dive into the specifics of Rule 506(d)(2)(ii), Rule 506(d)(2)(iii), and Rule 506(d)(3), let's first establish a foundation by understanding Regulation D and Rule 506 in general. Regulation D, promulgated by the Securities and Exchange Commission (SEC), provides exemptions from the registration requirements of the Securities Act of 1933. This means that companies can raise capital without going through the extensive and often expensive process of registering their securities with the SEC. Rule 506 is one of the most commonly used exemptions under Regulation D.

Rule 506 allows companies to raise an unlimited amount of money through the private placement of securities, provided they meet certain conditions. There are two main types of Rule 506 offerings: Rule 506(b) and Rule 506(c). Rule 506(b) allows companies to raise capital from an unlimited number of accredited investors and up to 35 non-accredited investors, but it prohibits general solicitation or advertising. On the other hand, Rule 506(c) allows companies to engage in general solicitation and advertising, but it requires them to take reasonable steps to verify that all investors are accredited. Both Rule 506(b) and Rule 506(c) offerings are subject to the bad actor provisions outlined in Rule 506(d), which we will explore in detail.

It's important to note that while Regulation D provides exemptions from registration, companies are still subject to the anti-fraud provisions of the securities laws. This means that they cannot make false or misleading statements or omit material information when offering or selling securities. Compliance with Regulation D is crucial for companies seeking to raise capital efficiently and legally.

Rule 506(d): The "Bad Actor" Disqualification

Rule 506(d) is often referred to as the "bad actor" disqualification. This rule prevents companies with certain individuals involved from relying on the Rule 506 exemption if those individuals have a history of securities violations or other misconduct. The purpose of this rule is to protect investors by ensuring that offerings made under Rule 506 are not associated with individuals who have a track record of fraudulent or unethical behavior.

The rule identifies specific categories of individuals and entities, known as "covered persons," whose past misconduct can trigger the disqualification. These covered persons include the issuer, its directors, executive officers, general partners, and certain beneficial owners, as well as underwriters and placement agents involved in the offering. The types of disqualifying events include convictions for securities fraud, orders barring individuals from the securities industry, and certain SEC disciplinary actions. If a covered person has a history of such misconduct, the company may be prohibited from using the Rule 506 exemption unless an exception applies. Understanding the scope and implications of Rule 506(d) is essential for companies planning to raise capital under Rule 506.

Deep Dive into Rule 506(d)(2)(ii)

Now, let's zoom in on Rule 506(d)(2)(ii). This subsection provides an exception to the bad actor disqualification. Specifically, it states that a disqualification will not arise if the relevant order, judgment, or decree has been vacated or reversed. Imagine a scenario where a company wants to raise capital through Rule 506. One of its executive officers had a previous cease-and-desist order issued against them by the SEC related to a securities violation. Ordinarily, this would trigger the bad actor disqualification, preventing the company from using Rule 506. However, if that cease-and-desist order has been vacated or reversed by a court or the SEC, Rule 506(d)(2)(ii) provides an exception. This allows the company to proceed with its offering under Rule 506, despite the executive officer's past regulatory issue.

The key here is that the action must be completely undone. A mere modification or amendment of the order is not sufficient. It must be entirely vacated or reversed, meaning it is no longer in effect. This provision recognizes that sometimes, initial judgments or orders can be overturned upon further review or appeal, and it would be unfair to permanently bar a company from using Rule 506 based on an action that has been nullified. Companies must carefully document the vacation or reversal of any such orders to rely on this exception.

To leverage this rule effectively, companies need to maintain meticulous records and be prepared to demonstrate that the disqualifying event has indeed been fully vacated or reversed. Seeking legal counsel is advisable to ensure compliance and avoid potential pitfalls.

Exploring Rule 506(d)(2)(iii)

Moving on to Rule 506(d)(2)(iii), this subsection offers another exception to the bad actor disqualification. It states that a disqualification will not arise if the covered person demonstrates to the SEC that the disqualification is not necessary under the circumstances. This is often referred to as seeking a waiver from the SEC. Think of it as asking the SEC for a second chance or explaining why the past bad act shouldn't prevent the company from raising capital now.

To obtain a waiver under Rule 506(d)(2)(iii), the covered person must submit a formal application to the SEC, providing detailed information about the disqualifying event and explaining why a waiver is warranted. The SEC will consider various factors, such as the nature and severity of the violation, the covered person's subsequent conduct, and the potential impact on investors. The burden is on the covered person to convince the SEC that granting the waiver is in the public interest and consistent with investor protection. The SEC has discretion in deciding whether to grant a waiver, and its decisions are often fact-specific. This process can be time-consuming and requires careful preparation and strong legal advocacy.

Imagine a scenario where a company wants to raise capital, but its CEO was previously subject to a regulatory order. The CEO petitions the SEC, demonstrating that the violation occurred several years ago, they have since taken significant steps to enhance compliance within the company, and the offering is structured to provide strong investor protections. If the SEC is persuaded by these arguments, it may grant a waiver, allowing the company to proceed with its Rule 506 offering. This provision provides a pathway for companies and individuals to overcome past misconduct and access the capital markets, but it requires a compelling case and the SEC's approval.

Understanding Rule 506(d)(3)

Now, let's discuss Rule 506(d)(3). This subsection addresses situations where the disqualifying event occurred before September 23, 2013. It states that a disqualification will not arise under Rule 506(d) if the event would have triggered disqualification solely as a result of the amendments to Rule 506(d) that became effective on that date. Basically, if something happened before the rule changed and it wouldn't have been a problem before the change, it's not a problem now. This is like a grandfather clause, acknowledging that the rules have evolved and it's unfair to penalize people retroactively for things that were not considered disqualifying at the time they occurred.

To understand this rule, it's helpful to know that the SEC amended Rule 506(d) in 2013 to broaden the scope of disqualifying events and covered persons. Prior to these amendments, certain types of misconduct or affiliations may not have triggered a disqualification. Rule 506(d)(3) provides relief for companies and individuals who might have been caught off guard by the expanded scope of the rule. However, it's important to note that this exception only applies to events that would not have been disqualifying under the pre-2013 version of the rule. If the event would have triggered disqualification even before the amendments, this exception does not apply.

For example, if a company engaged an underwriter who had a securities-related conviction in 2010, and that type of conviction would not have triggered a bad actor disqualification under the pre-2013 rules, Rule 506(d)(3) would provide an exception, allowing the company to proceed with its Rule 506 offering. However, if the conviction was for a type of offense that would have been disqualifying even before the amendments, this exception would not be available.

Key Differences and Practical Implications

To recap, let's highlight the key differences between Rule 506(d)(2)(ii), Rule 506(d)(2)(iii), and Rule 506(d)(3):

• Rule 506(d)(2)(ii): This rule applies when a disqualifying order, judgment, or decree has been vacated or reversed. The key is that the action must be completely undone.
• Rule 506(d)(2)(iii): This rule involves seeking a waiver from the SEC, demonstrating that the disqualification is not necessary under the circumstances. This requires a formal application and SEC approval.
• Rule 506(d)(3): This rule provides relief for disqualifying events that occurred before September 23, 2013, but only if the event would not have triggered disqualification under the pre-2013 version of Rule 506(d).

The practical implications of these rules are significant. Companies facing a potential bad actor disqualification must carefully analyze the facts and circumstances to determine which, if any, of these exceptions may apply. If an order has been vacated or reversed, Rule 506(d)(2)(ii) provides a straightforward path to compliance. If not, the company may consider seeking a waiver from the SEC under Rule 506(d)(2)(iii), but this requires a compelling case and SEC approval. Finally, if the disqualifying event occurred before September 23, 2013, the company should assess whether Rule 506(d)(3) provides relief.

Navigating these rules can be complex, and it's crucial to consult with experienced securities counsel to ensure compliance and avoid potential pitfalls. Understanding these nuances can make the difference between a successful capital raise and a regulatory roadblock.

Conclusion

In conclusion, understanding the nuances of Rule 506(d)(2)(ii), Rule 506(d)(2)(iii), and Rule 506(d)(3) is essential for companies seeking to raise capital under Regulation D. These provisions offer exceptions to the bad actor disqualification, providing pathways for companies to overcome past misconduct or changes in regulations. Whether it's demonstrating that a disqualifying order has been vacated, seeking a waiver from the SEC, or relying on the grandfathering provision for pre-2013 events, careful analysis and strategic planning are key. By understanding these rules and seeking expert legal guidance, companies can navigate the complexities of securities regulations and achieve their capital-raising goals. Remember, compliance is paramount, and a thorough understanding of these rules can help ensure a smooth and successful offering. So, stay informed, stay compliant, and good luck with your capital-raising endeavors!