Reg D & Compliance
Bad Actor Disqualification: The Rule 506(d) Check Sponsors Can't Skip
The 'bad actor' rule — Rule 506(d) of Regulation D — disqualifies an offering from using the Rule 506 exemptions if certain people connected to the deal have a relevant disciplinary history. It exists to keep securities-law violators and other 'bad actors' from raising money under the most-used private-placement exemptions. For a sponsor, it means that before you rely on 506(b) or 506(c), you have to confirm that you — and everyone covered by the rule — are clean, because a single disqualifying event in the wrong person can sink the entire offering's exemption.
By One Million Media5 min read
This guide is for sponsors and GPs who need to perform — and document — the bad-actor check that's a mandatory part of any Reg D 506 raise. It's an unglamorous compliance step that's easy to overlook on a first deal, and the consequence of overlooking it is severe: lose the exemption, and your private offering becomes an unregistered public sale. The screening itself is straightforward once you know who's covered and what counts.
Who the rule covers
Rule 506(d) reaches a defined set of people connected to the offering — not just the sponsor personally. A disqualifying event affecting any 'covered person' can disqualify the whole deal, which is why the screen has to extend beyond yourself:
- The issuer (the offering entity) and its directors, executive officers, and other officers participating in the offering.
- General partners and managing members of the issuer.
- 20%-or-more beneficial owners of the issuer's voting equity.
- Promoters connected to the offering, and any investment manager or its principals (for pooled funds).
- Compensated solicitors — anyone paid to solicit investors — and their directors, officers, and managing members.
For a typical syndication, that means the sponsor, the GP entity and its principals, any co-GPs or significant owners, and anyone you're paying to help raise must all be screened. The 20% owner threshold is a common surprise — a large passive investor who crosses it can become a covered person, so sponsors watch their cap table for this.
What counts as a disqualifying event
Disqualifying events are specific categories of legal and regulatory trouble, generally those occurring within defined lookback periods. The main buckets:
| Event type | Examples |
|---|---|
| Criminal convictions | Securities- or finance-related felonies/misdemeanors (within 5–10 years) |
| Court injunctions/restraining orders | Orders barring securities or financial misconduct (within 5 years) |
| Regulatory orders | SEC, state, or banking-regulator orders barring or suspending activity |
| SEC disciplinary orders | Cease-and-desist orders for scienter-based or registration violations |
| SRO bars | Bars from FINRA or other self-regulatory organizations |
| USPS false-representation orders | False-representation or fraud orders |
The events generally must have occurred during the applicable lookback (commonly five or ten years depending on type). Importantly, the rule applies to disqualifying events that happen on or after September 23, 2013 (when the rule took effect) for the disqualification itself — events before that date don't disqualify but must be disclosed to investors. That disclosure obligation is a separate, easy-to-miss requirement.
How sponsors screen and document
Compliance with Rule 506(d) has two parts: confirm no covered person triggers a disqualification, and exercise 'reasonable care' to find out. Reasonable care is itself a requirement — you can't simply assume everyone is clean:
- Identify every covered person: list the issuer, GP entity and principals, 20%+ owners, promoters, and any compensated solicitors.
- Collect bad-actor questionnaires: have each covered person complete a written certification disclosing any relevant events.
- Conduct reasonable diligence: this can include background checks and regulatory database searches in addition to the questionnaires.
- Disclose pre-2013 events: any matter that would have been disqualifying but occurred before the rule's effective date must be disclosed to investors in the offering materials.
- Document and update: keep the questionnaires and diligence on file, and re-confirm for long or continuous offerings, since a new event mid-raise can disqualify going forward.
The 'reasonable care' exception matters: if a disqualifying event exists but the issuer didn't know and couldn't have reasonably known despite proper diligence, the offering may not be disqualified. That's exactly why the questionnaire-and-diligence process isn't just box-checking — it's the evidence that establishes your reasonable care if a problem later surfaces.
Why it matters and what to do
A bad-actor disqualification doesn't fine you — it removes your ability to use Rule 506 at all for the offering, which for most syndications means losing the exemption entirely and facing an unregistered securities sale. There's no cure for an existing disqualification short of a waiver from the SEC, which is discretionary and not guaranteed. So this is a check you do before you raise, not after a problem appears.
Practically, the bad-actor screen should be a standard part of your pre-offering checklist, run by or with your securities attorney, every time. Most sponsors are entirely clean and the process is quick — but the screen and its documentation are non-negotiable, both to confirm eligibility and to preserve the reasonable-care defense. This is educational information, not legal advice; run your specific facts past counsel before relying on the exemption.
Frequently asked questions
What is the bad actor rule (Rule 506(d))?
It's a Regulation D provision that disqualifies an offering from using the Rule 506 exemptions if a 'covered person' connected to the deal has a relevant disciplinary history — such as certain criminal convictions, court injunctions, or regulatory orders. It keeps securities-law violators from raising money under the most-used private-placement exemptions.
Who is a 'covered person' under the bad actor rule?
The issuer and its directors, executive officers, and participating officers; general partners and managing members; 20%-or-more beneficial owners of voting equity; promoters; investment managers and their principals for pooled funds; and compensated solicitors and their principals. For a syndication, that typically means the sponsor, the GP entity and its principals, large owners, and anyone paid to help raise.
What events trigger disqualification?
Specific categories within defined lookback periods: securities- or finance-related criminal convictions, court injunctions and restraining orders, regulatory and SEC disciplinary orders, bars from self-regulatory organizations like FINRA, and certain false-representation orders. Events before the rule's September 23, 2013 effective date don't disqualify but must be disclosed to investors.
How do sponsors comply with Rule 506(d)?
By identifying every covered person, collecting written bad-actor questionnaires, conducting reasonable diligence such as background and regulatory-database checks, disclosing any pre-2013 events in the offering materials, and documenting and updating the screen. Exercising 'reasonable care' is itself required and establishes a defense if an undisclosed event later surfaces.
What happens if an offering is disqualified?
It loses the ability to use Rule 506, which for most syndications means losing the exemption entirely and facing an unregistered securities sale. There's generally no cure short of a discretionary SEC waiver. That's why the bad-actor screen must be completed before raising, ideally with securities counsel, rather than after a problem emerges.
Keep reading
This article is for educational purposes only and is not legal, investment, tax, or securities advice. Securities offerings are regulated; always work with your securities attorney to structure and run your offering. One Million Media is a marketing and lead-generation provider — not a broker-dealer, investment adviser, or law firm.
