Rule 506(d) of Regulation D — the bad actor disqualification rule — is one of the most underestimated landmines in private securities practice. It does not require intent. It does not require that the issuer knew about the disqualifying event. If a covered person has a qualifying history and the issuer fails to catch it, the exemption is gone. That means the offering was conducted without a valid exemption from registration, which opens the door to rescission rights, SEC enforcement, and state securities claims. Issuers and managers treat this as checkbox compliance at their peril.

The Statutory Framework

Rule 506(d) was adopted in 2013, implementing the JOBS Act's mandate to add bad actor disqualification to the existing Rule 506 framework. Prior to that, Regulation D contained no such provision — an anomaly, since most other exemptions under the Securities Act (Regulation A, Regulation Crowdfunding, Rule 505) had long included disqualification provisions modeled on Regulation A's historical requirements.

The rule operates as a flat prohibition: an issuer cannot rely on Rule 506 — either 506(b) or 506(c) — if any covered person is subject to a disqualifying event at the time of the sale. There is no cure provision. A disqualifying event is not a deficiency you can remediate with additional disclosure or enhanced procedures. The only path forward is to remove the covered person from their role before the next sale, or obtain a waiver from the SEC.

Who Is a Covered Person?

The definition of "covered person" under Rule 506(d)(1) is deliberately broad. It encompasses:

  • The issuer itself — including any predecessor or affiliated issuer that was disqualified within the relevant look-back period.
  • Directors and officers of the issuer — any director, executive officer, other officer participating in the offering, general partner, or managing member.
  • Beneficial owners of 20% or more of the issuer's outstanding voting equity securities — calculated on a fully diluted basis. This threshold captures controlling investors and sponsors in fund structures.
  • Promoters — as that term is defined in Rule 405, meaning any person who, directly or indirectly, takes the initiative in founding and organizing the issuer's business or enterprise.
  • Investment managers and principals of pooled investment fund issuers — this specifically captures fund managers, general partners, and managing members of funds that are the issuer.
  • Compensated solicitors — any person compensated (directly or indirectly) for soliciting purchasers in the offering, and any director, executive officer, or other officer participating in the offering of such compensated solicitors. This is the provision that sweeps in placement agents and their key personnel.

The compensated solicitor provision deserves particular emphasis. If a fund manager engages a placement agent to help raise capital, every director and officer of that placement agent who participates in the offering is a covered person. This means the issuer bears responsibility for conducting due diligence on individuals they may have never met. The issuer cannot simply rely on representations from the placement agent — although those representations are important for the contractual indemnification structure — because the rule's disqualifying effect is automatic.

The Triggering Events

Rule 506(d)(1) enumerates the disqualifying events with considerable specificity. The major categories are:

  • Criminal convictions: Conviction of any felony or misdemeanor in connection with the purchase or sale of a security, making a false filing with the SEC, or arising out of the conduct of a broker, dealer, municipal securities dealer, investment adviser, or paid solicitor of purchasers of securities. Look-back period: 10 years before the sale.
  • Court injunctions and restraining orders: Any injunction or restraining order currently in effect entered by a court of competent jurisdiction in connection with the purchase or sale of a security, making a false filing with the SEC, or arising out of the conduct of specified financial intermediaries. These are permanent in effect — there is no look-back period, only whether the order is currently operative.
  • Final orders from banking and insurance regulators: Final orders from the CFTC, bank regulatory agencies (OCC, FDIC, Federal Reserve, NCUA), state banking regulators, state insurance commissions, or state securities regulators that bar the person from associating with regulated entities or from engaging in securities activities. Look-back period: 10 years. This provision reaches people whose regulatory history does not involve the SEC at all.
  • SEC disciplinary orders: Any SEC order entered pursuant to Sections 15(b), 15B(c), 15C(c), or 203(e) or (f) of the Investment Advisers Act that suspends or revokes the person's registration, bars the person from association with a regulated entity, or imposes limitations on the person's activities. These orders are disqualifying for so long as they remain in effect.
  • SEC cease-and-desist orders: Any SEC order requiring compliance with, or prohibiting violations of, the federal securities laws — specifically under Section 8A of the Securities Act or Section 21C of the Exchange Act — that remains in effect.
  • Suspension or expulsion from SRO membership or association: Any suspension or expulsion from membership in, or association with, a registered national securities exchange or registered national or affiliated securities association (i.e., FINRA). Look-back period: 10 years.
  • Registration registration denial or revocation: Any SEC order entered under Section 8 of the Securities Act suspending or revoking a registration, or making a Regulation A offering of securities ineligible. No specific look-back; applicable while in effect.
  • U.S. Postal Service false representation orders: A catch-all covering false representation orders under the federal mail fraud statutes. Look-back period: 5 years.

The look-back periods matter in practice. A criminal conviction from 11 years ago does not disqualify. A FINRA bar from 8 years ago does. The date of the conviction or order is measured against the date of the most recent sale in the offering — meaning an offering that remains open for multiple closings must be re-analyzed at each close.

Disqualification vs. Disclosure: The Pre-2013 Carve-Out

Rule 506(e) creates a critical distinction that is frequently misunderstood. Disqualifying events that occurred before September 23, 2013 (the rule's effective date) do not disqualify the issuer from relying on Rule 506. Instead, they require disclosure to purchasers of the disqualifying event, in writing, a reasonable time before the sale. This disclosure obligation is unconditional — it applies regardless of whether the issuer considers the old event material by conventional standards. Failure to make the disclosure when required is itself a violation, even though the pre-2013 event does not technically void the exemption.

In practice, this means the covered persons analysis has two outputs for each covered person: (1) does this person have a post-September 2013 disqualifying event that bars the offering entirely? and (2) does this person have a pre-September 2013 event that requires disclosure? Both questions must be answered.

How to Conduct the Due Diligence

There is no prescribed method for conducting covered persons due diligence, but the SEC has made clear that reliance on representations alone — without independent verification — is not sufficient to establish a reasonable belief that no disqualification exists. A defensible diligence process typically includes:

  • FINRA BrokerCheck: Covers all registered persons and broker-dealers, including disciplinary history, regulatory actions, criminal disclosures, civil judicial actions, and customer complaints. BrokerCheck does not cover persons who were never FINRA-registered, but it is the first and easiest search.
  • SEC EDGAR and the SEC's Actions database: The SEC's website maintains a searchable database of litigation releases, administrative proceedings, and contested orders. EDGAR allows searches of enforcement-related filings and suspension orders.
  • PACER: The federal courts' electronic records system allows searches of federal criminal and civil court records by name. Criminal conviction searches should include both federal and state jurisdictions.
  • Commercial background check services: For state court records and final orders from banking and insurance regulators, commercial services covering nationwide criminal and civil databases are typically required. These are not foolproof, but they document a reasonable process.
  • Representations and questionnaires: Each covered person should complete a signed questionnaire representing their history with respect to each category of disqualifying event. This creates contractual accountability and helps identify issues the covered person may disclose voluntarily.

The diligence file should be documented and retained. In an SEC examination, examiners routinely ask how the issuer verified covered person status and what searches were conducted.

Placement Agent Agreements and Contractual Protections

Because placement agents and their personnel are covered persons, and because the issuer typically has limited visibility into their history, placement agent agreements should contain robust representations and warranties. At minimum, the placement agent should represent and warrant that neither it nor any of its participating directors, officers, or associated persons is subject to any disqualifying event under Rule 506(d), and that it has conducted its own internal diligence to confirm this. The agreement should include an obligation to promptly notify the issuer if any covered person becomes subject to a disqualifying event during the offering period, and an indemnification provision covering losses arising from any breach of the bad actor representations.

These contractual protections do not cure a disqualifying event if one exists — the exemption is still lost — but they allocate liability and create a recovery mechanism. More importantly, a well-drafted placement agent agreement gives the issuer grounds to demand removal of a disqualified individual from the engagement before any damage occurs.

Discovering a Disqualifying Event Mid-Offering

If a covered person becomes subject to a disqualifying event after the offering commences — for example, if a placement agent employee is hit with an SEC cease-and-desist order — the issuer must act immediately. The options are: (1) remove the covered person from any role in the offering before the next sale; (2) seek a waiver from the SEC under Rule 506(d)(2)(ii), which requires demonstrating that the participation of the disqualified person is not necessary to protect investors and that appropriate conditions can be imposed; or (3) terminate the offering. Simply proceeding without addressing the issue means every subsequent sale in the offering is made without a valid exemption.

SEC waivers are available but not automatic. The SEC evaluates waiver requests based on the nature of the disqualifying event, the covered person's role, and the existence of investor protection conditions. For events involving fraud or investor harm, waivers are rarely granted.

State-Level Analogues

While Regulation D preempts state registration requirements for covered securities, it does not preempt state anti-fraud authority. Several states — including California, Massachusetts, and New York — have their own bad actor provisions that apply to intrastate activities and may cover different conduct or different persons than Rule 506(d). Some state provisions use shorter look-back periods; others are triggered by events that do not appear in the federal rule. Issuers conducting offerings with investors in multiple states should confirm that their covered persons analysis satisfies applicable state requirements as well, particularly where placement agent relationships involve state-registered broker-dealers.

The bad actor rules are not complex in concept, but they are demanding in execution — particularly because they require ongoing monitoring, not just a one-time check at offering launch. Every new close, every new placement agent engagement, and every new affiliated entity warrants a fresh look.