Bad-actor disqualification under Rule 506(d), and how to check

Rule 506 of Regulation D is the safe harbor most private placements use to sell securities without registering them with the SEC. Rule 506(d), often called the bad-actor or disqualification provision, conditions that safe harbor on the people behind the offering: if a designated covered person has experienced a disqualifying event, the issuer generally cannot rely on Rule 506 at all.

The point is character and conduct. The rule is meant to keep individuals with a relevant history of securities-law or financial misconduct from raising money through the exemption. A disqualification is not a slap on the wrist for the issuer. It can remove the legal basis for the entire raise, which makes it a foundational item to check rather than a footnote.

The rule reaches a defined circle of people and entities connected to the offering, not just the issuer on paper. In general terms, covered persons include:

• The issuer itself, along with predecessor entities and affiliated issuers
• Directors, executive officers, and other officers participating in the offering, as well as general partners and managing members
• Beneficial owners of 20% or more of the issuer's outstanding voting equity, measured by voting power
• Promoters connected to the issuer or the offering
• Investment managers of a pooled investment fund issuer, and the directors, officers, general partners, or managing members of such a manager
• Compensated solicitors (including placement agents and brokers) and their directors, officers, general partners, and managing members

The relevant population extends beyond the founders. Placement agents and the principals of an external investment manager are squarely in scope, which is why diligence should gather the full roster of names, not just whoever signs the offering memorandum.

Disqualifying events are specific categories of legal and regulatory trouble, generally subject to look-back periods that vary by event type. The categories below describe the kinds of events the rule captures; they are illustrative rather than an exhaustive legal list.

• Certain criminal convictions in connection with the purchase or sale of a security, or arising from conduct as an underwriter, broker, dealer, or investment adviser
• Court injunctions and restraining orders that bar conduct in connection with securities or the business of an underwriter, broker, dealer, or investment adviser
• Certain SEC disciplinary orders against brokers, dealers, investment advisers, and their associated persons
• Certain SEC cease-and-desist orders relating to scienter-based fraud or to violations of the securities-registration provisions
• Final orders from state securities, banking, or insurance regulators that bar a person from the business or are based on fraudulent or deceptive conduct
• Suspension or expulsion from membership in a self-regulatory organization such as FINRA, or from association with an SRO member
• U.S. Postal Service false-representation orders
• Certain stop orders and orders suspending a Regulation A exemption

Look-back windows are defined per category and are commonly five to ten years measured from the relevant event, with some bars applying while they remain in effect. Because the precise window depends on the event type and the rule's exact wording, treat the timeframe as something to confirm against the order itself rather than to assume.

Two qualifications soften what would otherwise be an unforgiving rule. First, the disqualification does not apply if the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a covered person had a disqualifying event. Reasonable care generally contemplates a factual inquiry into the covered persons, and the depth of that inquiry scales with the facts and circumstances of the offering.

Second, events that pre-date the effective date of the rule are handled through disclosure rather than automatic disqualification. Under Rule 506(e), matters that would have triggered disqualification but occurred before the rule took effect must be disclosed in writing to investors a reasonable time before sale. Such pre-existing events do not themselves block reliance on Rule 506, but the failure to disclose them is its own problem.

Start by assembling the list of covered persons. The Form D filing and the offering documents name the issuer, its executive officers and directors, and often the placement agent; the private placement memorandum and subscription materials typically fill in promoters, the investment manager, and significant owners. With names in hand, work the public sources:

• SEC enforcement actions and administrative proceedings: search by individual and entity name for litigation releases, administrative orders, and cease-and-desist orders
• FINRA BrokerCheck: for brokers, broker-dealers, and placement agents, review disclosure events, regulatory actions, and employment history
• SEC Investment Adviser Public Disclosure (IAPD): for investment advisers and their associated persons, review Form ADV and disciplinary disclosures
• State securities regulators: check for final orders, bars, and administrative actions in the states where the principals operate
• Court records: federal and state dockets for injunctions, restraining orders, and relevant criminal matters
• Adverse media and corporate-records searches: surface prior ventures, aliases, and patterns that warrant a closer look

Cross-referencing is what makes this work. The same individual may appear under slightly different names or across multiple entities, so reconcile the roster from the Form D and offering documents against what each source returns. Where a covered person has a regulatory history, read the underlying order to understand whether it falls within a disqualifying category and look-back window. A disclosure event is not automatically a disqualifying event.

Bad-actor screening is not a substitute for full diligence on the business, the terms, and the disclosures, but it is an efficient filter. It is built around a defined list of people, a defined list of event types, and a defined set of public sources, which makes it both checkable and hard to fake.

Run it early. If a covered person carries a disqualifying event that the issuer has not addressed through reasonable care or Rule 506(e) disclosure, that is a question about the exemption the entire raise depends on. It is exactly the kind of issue you want surfaced before you wire funds, not after.