Bad Actor Disqualification in Reg D

Bad actor disqualification is one of those Rule 506 rules that can quietly wreck an otherwise clean Reg D raise. Under Rule 506(d), if certain people connected to your offering (called covered persons) have certain securities-law-related violations or orders in their past (called disqualifying events), your Rule 506 exemption can be unavailable. Founders should treat bad actor diligence like production code: figure out who’s covered, run the checks early, and don’t wait until the week you want to start taking wires.

Quick answer

Rule 506(d) can disqualify a Rule 506 offering if a covered person has had a disqualifying event (for example, certain criminal convictions, court injunctions/restraining orders, or SEC/other regulator orders) within the rule’s applicable lookback periods. If you’re disqualified and you sell anyway, you can create major liability and painful cleanup. Whether a specific event triggers disqualification is very fact-dependent, so if anything comes up, talk to securities counsel before proceeding.

The core issue: one person can taint the whole offering

Most founders think about Reg D in terms of mechanics (Rule 506(b) vs. 506(c), whether you’re generally soliciting, who is accredited, what you can and can’t say publicly). The bad actor rule is different: it’s a gate. If Rule 506(d) applies, it doesn’t matter that you did everything else “right.” Your Rule 506 offering can still be disqualified because of the history of one person connected to the issuer or the raise.

Who is a “covered person” under Rule 506(d)?

Rule 506(d) defines the people and entities whose past can trigger disqualification. In practice, the covered-person list commonly includes:

• The issuer (the company raising money)
• Directors and certain officers of the issuer
• General partners and managing members (where those roles exist)
• Promoters connected to the issuer in the offering
• People who are compensated for soliciting investors (and certain related persons)
• Beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power

Who is actually covered can depend on your facts and your cap table. The “20% voting equity” item is where founders often get surprised, especially when voting rights aren’t aligned with economics (super-voting stock, proxies, governance side arrangements, or unusual control terms). If your ownership or voting structure is complex, have counsel confirm your covered-person list.

What counts as a disqualifying event?

Rule 506(d) lists specific categories of disqualifying events. At a high level, they generally involve serious securities-law-related misconduct or regulator/court actions, including:

• Certain criminal convictions
• Certain court injunctions and restraining orders
• Certain final orders from the SEC and other financial regulators
• Suspension, expulsion, or bars involving certain self-regulatory organizations (like FINRA)
• SEC stop orders and certain orders suspending a Regulation A exemption
• U.S. Postal Service false representation orders

The details matter. Whether something is “final,” whether it fits the exact category in the rule, and whether it is within the relevant lookback period can be nuanced. Don’t rely on labels like “settlement” or “consent order” alone. If diligence flags anything, you usually want the underlying documents reviewed by securities counsel.

Lookback periods (and the September 23, 2013 cutover)

Rule 506(d) uses lookback periods that vary by event type. There’s also an important timing concept:

• Events that occurred before September 23, 2013 (the rule’s effective date) generally do not disqualify a Rule 506 offering, but they can still trigger a disclosure obligation (often referred to as Rule 506(e) disclosure).
• Events after that date can disqualify the offering if they meet the rule’s criteria and fall within the applicable lookback period.

So treat pre-2013 events as “still important,” not “ancient history.” The distinction between disclosure and disqualification often turns on dates and specifics.

How founders should check for bad actor issues

The goal is to find problems early enough that you still have choices. A practical process often looks like:

1. Build your covered-person list (including compensated solicitors and 20% voting owners).
2. Have each covered person complete a bad actor questionnaire and certify accuracy.
3. Run background and regulatory checks appropriate to the person’s role (and keep records).
4. Re-check if your covered-person set changes during the raise (new director/officer, new compensated solicitor, cap table or voting changes that create a new 20% voting owner).

Wefunder performs bad actor screening as part of its compliance process, but founders should still understand the rule and do early diligence themselves, especially if you’re running parallel fundraising efforts, bringing in anyone who “helps you raise,” or dealing with non-standard voting/control rights.

What if you find a potential disqualifying event?

Don’t freestyle it. The “fix” (if there is one) depends on what the event is, who it relates to, and why that person is covered. Depending on the facts, common paths may include:

• Removing or replacing a covered person (for example, changing roles so the person is no longer a covered person)
• Changing who is soliciting investors (and how they are compensated)
• Restructuring governance or ownership in a way that changes who is a 20% voting owner
• Making required disclosures where the rules call for disclosure rather than disqualification

This is squarely “call your securities lawyer” territory. Selling in a disqualified offering can create rescission risk and regulatory exposure, and it can also become a landmine in later financings or M&A diligence.

Common founder scenarios

Scenario 1: a new director joins mid-raise

If you add a director while you’re raising, that person is typically a covered person. Screen them before they join, or at least before you continue selling securities under Rule 506.

Scenario 2: a big early investor has unusual voting rights

Rule 506(d) looks at 20% beneficial ownership of voting equity based on voting power. If an investor has super-voting stock or other voting control that isn’t obvious from their economic ownership, they can become a covered person even if they don’t “feel” like a 20% holder.

Scenario 3: you hire someone who “knows investors”

If someone is compensated for soliciting investors, they (and certain related persons) can become covered persons. This is one reason compensated finders and “success fee” arrangements can create real securities-law risk in private fundraising, beyond just the bad actor issue.

Bad actor event types (high-level)

This table is a simplified map of the categories. It is not a substitute for Rule 506(d) itself or legal advice on a specific situation.

Event type (category)	Examples (high-level)	Lookback period
Criminal convictions	Certain felony or misdemeanor convictions in specified areas (including certain securities-related misconduct)	Varies by category; confirm in Rule 506(d) for the specific event
Court orders	Certain injunctions or restraining orders related to securities and other specified conduct	Varies by category; confirm in Rule 506(d) for the specific event
SEC and other regulator orders	Certain SEC orders (including certain cease-and-desist orders) and certain final orders of specified regulators	Varies by category; confirm in Rule 506(d) for the specific event
SRO bars/suspensions	Certain FINRA or other SRO suspensions, expulsions, or bars	Varies by category; confirm in Rule 506(d) for the specific event
SEC stop orders / Reg A orders	Certain SEC stop orders or orders suspending a Regulation A exemption	Varies by category; confirm in Rule 506(d) for the specific event
USPS false representation orders	Certain Postal Service fraud-related orders	Varies by category; confirm in Rule 506(d) for the specific event

Frequently asked questions

Is this serious?

Yes. If you sell securities in a disqualified Rule 506 offering, you can face investor rescission claims (investors demanding their money back) and regulatory enforcement risk. Even if you survive it operationally, it’s the kind of miss that can blow up a later financing or acquisition diligence process.

Does this apply to Reg CF too?

Regulation Crowdfunding has its own disqualification framework, and people often refer to it as “bad actor” disqualification too. But the details are not identical to Rule 506(d). Don’t assume that being “clean” under one automatically means you’re clean under the other.

Does Wefunder screen for bad actor issues?

Yes, bad actor screening is part of Wefunder’s compliance process. Founders should still run their own early diligence on anyone likely to be covered, especially before adding a director, hiring a compensated solicitor, or taking money from someone who may have significant voting power.

Bottom line

Bad actor disqualification is one of the fastest ways to accidentally turn a valid Rule 506 raise into a legal mess. Build your covered-person list early, run questionnaires and checks before you launch, and escalate any flags to securities counsel immediately. This is usually a solvable problem if you catch it before you sell.