SEC Rule Change Alert: New "Bad Actor" Rule Complicates Raising Capital in Private Placements

On July 10, 2013 the Securities and Exchange Commission ("SEC") expressed faith in the old adage "If you lie down with dogs, expect to get fleas" by approving its final Bad Actor Rule for Rule 506 private placements. 

 Here's a link to the page of the SEC's website that contains the Bad Actor Rule in SEC Release 33-9414:  Most of the SEC's release explains the rule and the reasons for it, but the full text of the new rule is at the end of the release.  

Some people might complain that the SEC is making many people pay for a few people's bad acts.  If the SEC makes it more difficult for a business to raise capital, because a person related to the business or an intermediary did something bad at some point during the past ten years, all the investors in the business risk losing their investment.  Is this additional investor risk necessary - especially in light of the fact that the bad action doesn’t have to be related to this current business?  

Any impediment to raising capital is likely to scare away some investors, because a business' ability to raise additional capital is important to many business plans.  So, investors have another thing to look for in due diligence.   Before you invest, ask about the past history of all the officers, directors, other investors and intermediaries.  

 But after much debate, the SEC seems to have decided that it's more important to try to make it more difficult for the fleas to bite new investors than to worry about collateral damage to existing investors, founders and employees. 

Of course, many teachers think cancelling recess for the entire class is a useful disciplinary tool even if only two children in the class are misbehaving.  Teachers use  class-wide punishments to exert peer pressure.  This can be effective if it motivates the other twenty children in the class to police the misbehaving students.  But students usually have no choice about their classes and their teachers.  Investors can just decide not to invest.   Only time will tell whether the SEC's disciplinary strategy works so that investors get rid of bad actors or whether this policy will just reduce the amount of capital American businesses can raise.

Read on...

This post is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this post without obtaining the advice of an attorney. If you have questions concerning this post, please contact James F. Verdonik at or 919.277.9188.


© 2017 Ward and Smith, P.A. For further information regarding the issues described above, please contact James F. Verdonik.

We are your established legal network with offices in Asheville, Greenville, New Bern, Raleigh, and Wilmington, NC.

Subscribe to Ward and Smith