In the U.S. securities framework, issuers often rely on exemptions like Regulation A and Regulation D to raise capital without registering their offerings. However, certain disqualifying events can bar a company from using these exemptions, particularly if there has been past misconduct involving the issuer, its officers, or significant shareholders. This guide will explore the disqualification rules for exempt offerings, when waivers may be available, and the factors that the Securities and Exchange Commission (SEC) considers when reviewing waiver requests.

Disqualification Rules under Regulation A and Rules 505 and 506

Under Rules 262 and 505 of Regulation D and Rule 506(d) of Regulation D, disqualification from exemption can occur if certain individuals or entities associated with the issuer have engaged in prohibited conduct. These rules cover a broad range of actors, including the issuer’s directors, officers, general partners, certain equity holders, and individuals compensated for soliciting investors.

For example:

• Regulation A and Rule 505 include 10% beneficial owners of any class of the issuer’s securities.

• Rule 506(d) applies a higher threshold, including beneficial owners of 20% or more of the issuer’s voting equity securities.

The covered “bad acts” leading to disqualification may involve:

• Administrative Orders and Industry Bars: Orders from the SEC or other authorities barring individuals from certain financial industries.

• Injunctions related to securities violations.

• Specified Criminal Convictions related to fraud or deceit in securities transactions.

Additional Provisions under Rule 506(d)

Rule 506(d) broadens disqualification criteria beyond those in Regulation A and Rule 505 by adding other specific categories, such as:

• Cease and Desist Orders: Orders from the SEC related to anti-fraud provisions or violations of Section 5 of the Securities Act.

• Regulatory Authority Orders: Final orders from certain state and federal regulatory bodies can also disqualify issuers if they involve fraud or deceptive conduct.

SEC Waivers of Disqualification

When a disqualification event occurs, issuers may seek a waiver from the SEC. The SEC has delegated authority to the Director of the Division of Corporation Finance to grant such waivers, though the Commission itself retains the power to review and decide on these requests. To obtain a waiver, issuers must demonstrate “good cause” that the disqualification is unnecessary in their specific case.

Key Factors in SEC Waiver Evaluations

The SEC evaluates multiple factors when determining whether to grant a waiver, with a focus on the issuer’s fitness to participate in exempt offerings. No single factor is decisive, and the applicant must clearly justify why a waiver is warranted. Below are the primary factors the SEC considers:

1. Responsibility for the Misconduct

   • The SEC examines who was responsible for the disqualifying conduct. For example, if an executive officer or control person was involved in the misconduct, it could weigh against a waiver, particularly if the individual remains in a position of influence.

   • Additionally, the SEC will review the issuer’s response to the misconduct, including whether there were any warning signs ignored or if there was obstruction of regulatory investigations. Any action by the issuer that obstructed the investigation is a negative factor, though legitimate legal advocacy is not considered obstruction.

2. Duration and Scope of Misconduct

   • The SEC considers whether the misconduct was a single isolated incident or occurred over an extended period. A one-time violation is more favorable for a waiver than misconduct that spanned years.

3. Remedial Measures Taken by the Issuer

   • The SEC looks favorably on companies that take proactive steps to prevent future misconduct, such as implementing new compliance programs, improving corporate governance, or terminating individuals responsible for the violations.

   • Remedial steps taken promptly after the misconduct indicate that the company is less likely to engage in future violations, which strengthens the waiver request.

4. Impact if the Waiver is Denied

   • The SEC considers the potential hardship on the issuer and its stakeholders if the waiver is denied. This includes the impact on investors, clients, or customers. Issuers should provide specific evidence showing how frequently they use the exemption or how its loss would affect their business.

The Burden of Proof for Waivers

Applicants must provide a thorough justification when seeking a waiver, showing why disqualification is unnecessary. They are encouraged to include any corrective actions taken, details of those involved in the misconduct, and the expected impact of disqualification on their business.

In certain cases, the SEC may require that the issuer provide full disclosure of the disqualifying event to investors prior to any future offerings using the relevant exemptions. This ensures transparency for investors in exempt offerings, who lack some of the protections associated with fully registered securities offerings.

Final Considerations

Navigating the SEC’s waiver process can be complex, and seeking counsel early on can make a significant difference in the application outcome. The waiver process exists to balance investor protection with the recognition that some disqualifying events may not necessarily indicate a broader risk if the issuer has demonstrated proactive compliance and remediation.

* * *

Attorney Advertising—Anderson P.C. is a U.S. law firm and provides this information as a service to clients, prospective clients, and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.

Anderson P.C. is a boutique law firm dedicated to defending clients in government investigations and securities enforcement actions initiated by the SEC, FINRA, DOJ, and other regulatory bodies. We provide focused, strategic counsel and regulatory guidance across the full spectrum of federal laws and regulations affecting broker-dealers, investment advisers, banks, asset managers, private funds, public companies, senior executives, and digital assets. Our deep expertise allows us to navigate complex legal challenges and deliver results-driven solutions tailored to our clients' unique needs.

If you have any questions or need legal assistance related to government investigations, securities enforcement actions, or regulatory compliance, please don't hesitate to contact us. Our team at Anderson P.C. is here to provide the expert guidance and support you need to navigate these complex challenges.