SECURITIES | 2026-10-31

Rule 506(d) Bad-Actor Disqualification: Who Must Be Vetted Before a Regulation D Private Placement in California

How the covered-person list, the disqualifying events, the look-back periods, and the reasonable-care exception decide whether a California issuer keeps its Rule 506 exemption

Most private capital raised in California is raised under Rule 506 of Regulation D, the exemption that lets a company sell securities without registering the offering with the SEC. Rule 506 is popular precisely because it is a safe harbor: comply with its conditions and the offering is exempt. But s

Why Rule 506(d) exists

Rule 506 of Regulation D, codified at 17 C.F.R. § 230.506, is the workhorse exemption for private placements. It lets an issuer raise an unlimited amount from accredited investors without registering the securities, as long as the offering meets the rule's conditions. Congress decided in the Dodd-Frank Act that this powerful exemption should not be available to people with a history of securities-law violations or certain other misconduct. Section 926 of Dodd-Frank directed the SEC to adopt disqualification rules, and the SEC did so in Release No. 33-9414, adopting Rule 506(d) and the related disclosure rule 506(e). The rule took effect on September 23, 2013.

The design is binary and unforgiving: if a disqualifying event exists in the record of any covered person, and the event occurred on or after the effective date, the issuer simply cannot use Rule 506 for that offering. There is no partial exemption and no cure that erases the event. That is why vetting has to happen before the offering begins, not after an investor complains.

Who is a covered person

Rule 506(d) applies to a defined list of people connected to the offering. The issuer must identify and vet each of them:

The issuer itself, including any predecessor and any affiliated issuer.
Directors, general partners, and managing members of the issuer.
Executive officers, and any other officer who participates in the offering.
Any beneficial owner of 20 percent or more of the issuer's outstanding voting securities, measured by voting power.
Any promoter connected to the issuer at the time of sale.
For a pooled investment fund, the investment manager and its principals.
Any person compensated for soliciting investors — a placement agent or finder — and the directors, officers, and other participating principals of that solicitor.

The 20 percent beneficial-owner trigger surprises many issuers. A passive investor who crosses 20 percent of the voting power becomes a covered person, so a disqualifying event in that investor's history can taint the raise even though the investor has nothing to do with running the company.

Two refinements on the covered-person list are worth flagging because they catch issuers off guard. First, the list reaches not only officers with formal titles but any "other officer participating in the offering," so a vice president who does not sit on the executive team but runs the fundraising can be a covered person while a more senior officer who stays out of the raise is not. The test is functional participation in the offering, not rank. Second, for placement agents and finders the rule reaches through to that firm's own directors, officers, and participating principals, so an issuer that hires a broker-dealer inherits the need to confirm that the broker-dealer's key people are clean. Prudent issuers therefore ask the placement agent to represent in writing that neither it nor its covered principals has a disqualifying event, and to give notice if that changes before the final closing.

What events are disqualifying

The categories of disqualifying events are set out in the rule and track serious, finding-based outcomes rather than mere allegations:

Certain criminal convictions in connection with the purchase or sale of a security, false SEC filings, or acting as an underwriter, broker, dealer, or investment adviser.
Certain court injunctions and restraining orders that bar conduct in connection with securities.
Final orders of state securities, banking, insurance, or credit-union regulators, and of federal banking and commodities regulators, that bar the person or that are based on fraudulent conduct.
Certain SEC disciplinary orders under the Securities Exchange Act and Investment Advisers Act.
SEC cease-and-desist orders relating to scienter-based antifraud violations or to registration-provision violations.
SEC stop orders and orders suspending a Regulation A exemption.
Suspension or expulsion from a self-regulatory organization such as FINRA, or from association with an SRO member.
U.S. Postal Service false-representation orders.

Look-back periods: when an old event stops mattering

Not every event lasts forever. The rule assigns each category a look-back period measured from the date of the event to the date of the proposed sale:

Criminal convictions: within ten years of the sale generally, but within five years for the issuer, its predecessors, and affiliated issuers.
Court injunctions and restraining orders: entered within the preceding five years and still in effect at the time of sale.
Final regulator orders: fraud-based bars issued within ten years; other bars disqualify only while they remain in effect.
SEC cease-and-desist orders: issued within five years and still in effect.
Stop orders and Postal Service orders: entered within the preceding five years.
SEC disciplinary orders: disqualify only while the order's prohibition or requirement remains in force; censures and paid civil penalties, standing alone, are not disqualifying.

A key drafting point in the rule is that the look-back runs from the date of the order or conviction, not from the date of the underlying conduct. That distinction can decide whether a years-old matter still bars a current raise.

The reasonable-care exception

The rule gives an issuer a genuine defense. An offering is not disqualified if the issuer establishes that 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 requires a factual inquiry — the issuer must actually investigate whether any covered person is disqualified. In practice that means questionnaires to every covered person, representations and covenants in the subscription and placement-agent agreements, and, where the facts warrant, independent checks against regulatory and FINRA records. An issuer that simply assumed everyone was clean has not exercised reasonable care; an issuer that papered a diligent inquiry and was misled by a covered person's false answer has a real argument that the exception applies.

Rule 506(e): disclosing pre-September 2013 events

Events that occurred before September 23, 2013 do not disqualify an offering, because the rule applies disqualification only to events on or after the effective date. But they are not irrelevant. Rule 506(e) requires the issuer to disclose, in writing to each purchaser a reasonable time before the sale, any matters that would have been disqualifying had they occurred after the effective date. The disclosure must be made with reasonable prominence. An issuer that fails to make the required 506(e) disclosure loses the Rule 506 exemption for that offering — subject to the same reasonable-care exception — so the disclosure duty is as serious as the disqualification itself.

How Rule 506 fits with the statutory private-offering exemption

Rule 506 is a safe harbor under Section 4(a)(2) of the Securities Act, codified at 15 U.S.C. § 77d(a)(2), which exempts transactions by an issuer not involving a public offering. Regulation D, at 17 C.F.R. §§ 230.501–230.508, gives issuers defined conditions that, if met, establish the exemption without having to litigate the open-ended "public offering" question. Rule 506 comes in two forms: Rule 506(b) at 17 C.F.R. § 230.506(b), which allows up to 35 non-accredited but sophisticated purchasers and bars general solicitation, and Rule 506(c) at 17 C.F.R. § 230.506(c), which permits general solicitation but requires the issuer to take reasonable steps to verify that all purchasers are accredited. The bad-actor disqualification in 17 C.F.R. § 230.506(d) applies to both. An issuer cannot escape the disqualification by switching from 506(b) to 506(c) or back; a disqualified covered person taints either path.

This matters because the choice between 506(b) and 506(c) is often driven by marketing strategy, and founders sometimes assume the compliance analysis changes with it. For the bad-actor rule it does not. The covered-person list, the disqualifying events, and the reasonable-care duty are identical under both subdivisions, so the vetting has to happen regardless of which marketing approach the issuer chooses.

The parallel bad-actor rule in Regulation A

Rule 506(d) is not the only disqualification an issuer may face. Regulation A — the exemption for larger, more public-facing small offerings — has its own bad-actor rule at 17 C.F.R. § 230.262, with a substantially similar list of covered persons and disqualifying events. An issuer that cannot use Rule 506 because of a covered person's history will usually find the same obstacle under Regulation A, so switching exemptions is rarely an escape. The practical consequence is that a disqualifying event is a company-level problem to be solved by addressing the person, not by shopping for a different exemption. Where a covered person's involvement cannot be unwound, the issuer's realistic options are a registered offering or seeking a waiver.

Continuing diligence through a rolling offering

Many private placements are not single-day events. A fund may hold a first closing and then continue accepting subscriptions for months, and a startup may raise on a rolling basis. Because disqualification is tested at the time of each sale, a covered person who was clean at the first closing but becomes the subject of a disqualifying order mid-raise can taint sales made after that date. The reasonable-care exception requires more than a one-time questionnaire in a rolling offering: the issuer needs covenants requiring covered persons to report new events, and a practice of refreshing the inquiry before later closings. An issuer that vetted everyone in January and closed new investors in September without rechecking has a weaker reasonable-care position than one that built ongoing reporting into its covered-person agreements.

What disqualification actually costs the issuer

Losing Rule 506 is not a technicality. Without a valid exemption, the securities sold in the offering were sold in violation of the registration requirements of Section 5 of the Securities Act. That exposes the issuer to rescission claims — investors can demand their money back — and to enforcement risk. It also means the issuer cannot rely on Rule 506's preemption of state blue-sky registration, so the California qualification requirements of the Corporate Securities Law come back into play. A disqualification discovered after closing can therefore unwind a completed raise, which is a far worse outcome than the modest cost of vetting up front.

Waivers and the SEC's discretion

The rule allows the SEC to grant a waiver of disqualification upon a showing of good cause that disqualification is not necessary under the circumstances. The relevant SEC division can also determine that disqualification should not arise from a particular order. Waivers are discretionary and fact-specific, and an issuer should not count on one; the sound course is to structure the deal so that no covered person is disqualified, or to remove or replace a disqualified covered person before the offering begins.

A note for California issuers: the blue-sky overlay

For a California issuer, the federal exemption is only half the picture. A valid Rule 506 offering is a "covered security" whose offer and sale are exempt from state registration under the National Securities Markets Improvement Act, so California cannot require the offering to be qualified. But California still requires a notice filing and fee, and the issuer must file the same Form D with both the SEC and the state. When bad-actor disqualification destroys the Rule 506 exemption, that federal preemption disappears with it, and the offering is suddenly subject to the qualification requirements of the California Corporate Securities Law — including Corporations Code § 25110 and the limited-offering exemption in Corporations Code § 25102(f). An issuer that loses Rule 506 cannot assume a California exemption will catch the offering, because California's own exemptions have their own conditions that may not be satisfied. The loss of the federal safe harbor can therefore trigger two separate compliance failures at once, which is why the bad-actor vetting protects the state position as much as the federal one.

A vetting checklist for a California private placement

Build the complete covered-person list early, including 20 percent voting owners and all paid solicitors and their principals.
Send a bad-actor questionnaire to every covered person and keep the signed answers.
Add representations, warranties, and notice covenants to subscription and placement-agent agreements so that a later event triggers a duty to tell the issuer.
Check the look-back period for each flagged matter against the date of the order or conviction, not the conduct.
Prepare written Rule 506(e) disclosure for any pre-September 2013 matter that would otherwise be disqualifying.
Document the whole inquiry so the reasonable-care exception is available if a covered person misled the issuer.

Frequently asked questions

When did Rule 506(d) take effect?

The SEC adopted the rule on July 10, 2013, and it took effect on September 23, 2013. Disqualification applies only to events occurring on or after that date and to sales made on or after that date.

Does a disqualifying event in one director's record taint the whole offering?

Yes. A disqualifying event in any covered person — including a director, a 20 percent owner, or a paid solicitor — makes Rule 506 unavailable for the entire offering, subject to the reasonable-care exception and any SEC waiver.

Is a passive 20 percent investor really a covered person?

Yes. Any beneficial owner of 20 percent or more of the issuer's voting power is a covered person, regardless of whether that investor is involved in the business or the offering.

Do censures or paid civil penalties disqualify a person?

Standing alone, no. SEC disciplinary orders disqualify only while a prohibition or requirement remains in effect; a censure or a paid civil penalty by itself is not a disqualifying event.

What is the reasonable-care exception?

An offering is not disqualified if the issuer shows it did not know, and could not have known through reasonable care, that a covered person was disqualified. Reasonable care requires an actual factual inquiry, such as questionnaires and contractual representations.

What does Rule 506(e) require?

For events before September 23, 2013 that would otherwise be disqualifying, the issuer must disclose them in writing to purchasers a reasonable time before the sale, with reasonable prominence, or lose the exemption.

Can the SEC waive a disqualification?

Yes. The SEC may grant a waiver on a showing of good cause, and the relevant division may determine that a particular order does not cause disqualification, but waivers are discretionary and should not be assumed.

What happens to the raise if the exemption is lost?

The securities were sold without a valid federal exemption, exposing the issuer to investor rescission claims and enforcement risk, and the California blue-sky qualification requirements are no longer preempted.

Related guides

For related reading, see our overview of securities and corporate governance, and our guide to California's Section 25102(f) limited-offering exemption, which often works alongside Rule 506 in a California private placement. Issuers weighing disclosure obligations should read those together.

Speak with a California securities attorney

If you are planning a Regulation D private placement and need to vet covered persons, respond to a bad-actor question, or evaluate whether an event disqualifies your raise, Trembach Law Firm can help. Call (818) 514-7680 to discuss your offering. Anatolii Trembach holds an LL.M. and is admitted to the California Bar.

This article is general legal information and not legal advice. Whether a particular event disqualifies an offering depends on the specific facts, dates, and covered persons involved. Consult a qualified securities attorney about your offering.

Contact Trembach Law Firm at (818) 514-7680 for a confidential consultation.

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