SEC Broadly Interprets Beneficial Ownership for Purposes of the Bad Actor Rule

January 7, 2014

Recently, the staff of the Division of Corporate Finance of the Securities and Exchange Commission (the “Staff”) issued additional questions and answers (“Q&A”) with respect to certain aspects of the bad actor provisions of Rule 506(d) under the Securities Act of 1933, as amended (“Rule 506(d)”). As discussed in our August 2013 memorandum, Rule 506(d) disqualifies securities offerings involving certain bad actors from reliance on the Rule 506 offering exemptions. The additional questions are Questions 260.28 – 260.32 and may be accessed here.

Disqualification under Rule 506(d) may arise based on the conduct of certain persons involved with the offering, including any beneficial owner of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power. While neither Rule 506(d) nor the adopting release specifically included a “look through” concept with respect to determining 20% beneficial ownership, the Staff has indicated in the Q&A that it interprets the term “beneficial owner” as used in Rule 506(d) in the same way “beneficial owner” is interpreted in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (“Rule 13d-3”)1. The Rule 13d-3 definition of “beneficial owner” is expansive and may, among other things, characterize as “beneficial owners” under Rule 506(d) persons beyond the actual investor (e.g., certain control persons), and may, for purposes of determining whether the 20% beneficial ownership level has been reached, require an issuer to aggregate separate investors that are under common control.

In light of the Staff’s broad interpretation of “beneficial owner”, advisers to private investment funds relying on the Rule 506 offering exemptions should consider taking the following steps: (i) conduct a revised analysis of its potential 20% beneficial owners using the Rule 13d-3 definition and (ii) further amend subscription agreements to obtain information regarding ownership of the private investment funds’ interests by investors that control or are controlled by, or are under common control with, other investors.

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If you have any questions regarding the information discussed above, please contact your Investment Management Group attorney at Seward & Kissel LLP.


1 A “beneficial owner” of a security under Rule 13d-3 is a person who “directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise has or shares (i) voting power which includes the power to vote, or to direct the voting of, such security; and/or (ii) investment power which includes the power to dispose, or to direct the disposition of, such security.”