Rule 506(d) Bad Actor Disqualification: Who It Covers and What It Misses
The rule that removes the exemption from a sponsor with the wrong history. It is narrower than its name suggests, and knowing where it stops tells you what a clean record does and does not prove.
Nearly every real estate syndication in the United States is sold under Rule 506 of Regulation D, in either its 506(b) or its 506(c) form. Since September 23, 2013, that exemption has carried a condition about people: if the issuer or anyone else the rule covers has a disqualifying event on their record, the exemption is simply unavailable.
That condition is paragraph (d) of the rule, and it is known as the bad actor disqualification. The SEC adopted it under Section 926 of the Dodd-Frank Act. The SEC's compliance guide, linked below, is the clearest statement of it and the source for everything in this article.
It matters to a passive investor for two reasons. It explains a paragraph that appears in almost every offering package, and it marks the edge of what the regulatory system checks for you before you invest.
Who is covered¶
The rule applies to a defined list of people and entities, which the guide calls covered persons. Mapped onto an ordinary syndication, the list reads as follows.
| Covered category | What it usually means in a syndication |
|---|---|
| The issuer, its predecessors and affiliated issuers | The LLC or limited partnership selling the units, and any commonly controlled entity selling in the same offering |
| Directors, general partners and managing members | The sponsor entity acting as manager or general partner |
| Executive officers, and other officers who take part in the offering | The principals who run the sponsor, and anyone with an officer title who works on the raise |
| Owners of 20% or more of the voting power | Measured on voting power, not on any single class of units |
| Promoters | Anyone who takes the initiative in founding the issuer, or receives 10% or more of its securities or proceeds in that connection |
| Paid solicitors of investors | Broker-dealers and other intermediaries paid to raise capital, and their own principals |
Pooled investment funds carry one more category, their investment manager and its principals, which reaches a fund of funds or SPV sitting between you and the deal.
The voting-power test has a consequence worth noticing. The guide says securities whose votes are limited to changes in the rights of their own class are not treated as voting securities. Limited partner units usually carry votes of about that kind, so a large passive holder is often outside the 20% category.
What counts as a disqualifying event¶
Eight kinds of event, most of them with a look-back window. The window runs from the date of the order or conviction, not from the date of the conduct behind it.
| Event | Window before the sale |
|---|---|
| Criminal conviction connected with securities, false SEC filings, or the business of a broker, dealer, adviser or paid solicitor | 10 years, or 5 years for the issuer and its affiliates |
| Court injunction or restraining order on the same subjects | Entered within 5 years and still in effect |
| Final order of a state securities, banking, insurance or credit union regulator, a federal banking agency, the CFTC or the NCUA | Bars count while they last; orders based on fraudulent, manipulative or deceptive conduct count for 10 years |
| SEC disciplinary order against a broker, dealer or adviser | While the suspension, bar or limitation lasts |
| SEC cease-and-desist order on scienter-based antifraud provisions or on Section 5 | Issued within 5 years and still in effect |
| SEC stop order or order suspending a Regulation A exemption | Within 5 years, or a pending proceeding |
| Suspension or expulsion from a self-regulatory organization such as FINRA | While it lasts |
| U.S. Postal Service false representation order | Within 5 years |
Three escape routes¶
Events before September 23, 2013 do not disqualify. Rule 506(e) requires the issuer to describe them in writing to purchasers a reasonable time before the sale instead. If an offering package contains a paragraph of that kind, it is the most direct disclosure of regulatory history you will receive, and it deserves a slow read.
Reasonable care. An issuer keeps the exemption if it did not know, and in the exercise of reasonable care could not have known, that a covered person was disqualified. The rule's instruction says reasonable care requires a factual inquiry, which in practice usually means a questionnaire completed by each covered person.
Waivers. The SEC can waive the disqualification for good cause. Separately, it does not arise if the court or regulator that entered the order says in writing that it should not.
What the rule does not see¶
This is the section with the most practical value, because a clean result under Rule 506(d) is easy to overread.
- Civil lawsuits by investors. A pile of investor complaints, settled or pending, is not a disqualifying event.
- Failed deals. Foreclosures, lost properties, capital calls and wiped-out equity are not events under the rule.
- Bankruptcy is not on the list.
- Most money penalties that have been paid, and censures, are not disqualifying.
- Anything outside the windows. A conviction eleven years old is no longer disqualifying for anyone.
- People who are not covered. A key employee without an officer role, an affiliated property manager, or an owner below the 20% voting line sits outside the list, whatever their record.
None of that is hidden. It is simply outside what this rule was written to catch. Whether a sponsor's history is acceptable is a much wider question, and the public records that answer it are covered in where to look for regulatory and litigation history.
What it means for your position¶
If a disqualified offering is sold under Rule 506 anyway, there is no exemption behind it. That makes it an unregistered sale of securities, and Section 12(a)(1) of the Securities Act gives a purchaser in such a sale a right to recover the price paid, within its conditions and limitation periods. A remedy against a sponsor whose deal is in trouble is worth less than it sounds, so the rule's real value to you is before the sale, not after.
A name that appears in the deck but not in the Form D, or the other way round, is not proof of anything. It is a question to ask, and how the sponsor answers it is information too. The wider method is in how to evaluate a sponsor.
Primary sources
Every factual claim above is traceable to a filing, a rule or an agency publication. These are the ones this article relies on.
- SEC, small entity compliance guide to bad actor disqualification under Rule 506sec.gov
- eCFR, 17 CFR 230.506, including paragraphs (d) and (e)ecfr.gov
- Investor.gov, Rule 506 of Regulation Dinvestor.gov
- SEC, Action Lookup for individuals and entitiessec.gov
- Securities Act of 1933, Section 12 (15 U.S.C. 77l)law.cornell.edu
Questions readers ask
What is the bad actor rule in Regulation D?
Rule 506(d) makes the Rule 506 exemption unavailable for an offering if the issuer or another covered person has a disqualifying event, such as certain criminal convictions, court injunctions or regulatory orders, within the look-back periods the rule sets. It applies to events on or after September 23, 2013.
Who counts as a covered person in a syndication?
The issuer and its affiliated issuers, its general partners or managing members, their executive officers and the officers who take part in the offering, anyone owning 20% or more of the voting power, promoters, and anyone paid to solicit investors, along with that solicitor's own principals.
Does a clean bad actor check mean the sponsor has a clean record?
No. The rule ignores civil lawsuits by investors, failed deals, bankruptcies, most fines that have been paid, and events outside its look-back windows. It also ignores people who are not on the covered list.
What happens if a sponsor sells under Rule 506 while disqualified?
The offering has no exemption to rely on, so it is an unregistered sale of securities. Section 12(a)(1) of the Securities Act gives purchasers in such a sale a right to recover what they paid, subject to its conditions and time limits.
What about events that happened before September 2013?
They do not disqualify the offering, but Rule 506(e) requires the issuer to describe them in writing to purchasers a reasonable time before the sale.
Read next
- Structures506(b) vs 506(c) Syndications: What Changes for the Investor506(b) vs 506(c): one Reg D exemption forbids advertising and takes your word on accreditation; the other permits marketing and requires proof.
- SponsorsRegulatory and Litigation History: Where to Actually LookFour public databases, none of them connected to each other, each covering a different part of a sponsor's record. Together they take about an hour.
- StructuresForm D on EDGAR: What the Sponsor Files, and How to Find the FilingEvery Regulation D offering files a Form D on SEC EDGAR. How to search EDGAR for a sponsor's Form D filings, what each field shows, and what it leaves out.
This article sits in section I, Deal Structures, which runs to 11 articles in reading order.