In the dynamic world of private securities offerings, reputation isn’t just a matter of image—it’s a matter of law. The U.S. Securities and Exchange Commission (SEC) created the “Bad Actor Rule” to ensure that those who have violated securities laws, engaged in fraud, or otherwise demonstrated misconduct cannot exploit regulatory exemptions such as Regulation D. This rule serves as both a safeguard and a statement: integrity is non-negotiable when it comes to raising capital. Regulation D (Reg D) is one of the most powerful tools available to startups and private companies. It allows issuers to raise funds without the costly and time-consuming process of registering their securities with the SEC. But that freedom comes with responsibility—and the Bad Actor Rule is the gatekeeper. It’s designed to protect investors from individuals or entities with a history of wrongdoing, ensuring that private markets remain transparent and trustworthy.
The Origins of the Bad Actor Rule
The Bad Actor Rule was born out of necessity. For decades, private placements under Regulation D operated with relatively little oversight compared to public markets. While this system worked well for legitimate companies, it also created opportunities for bad actors—people or organizations with a track record of fraud or securities violations—to take advantage of investors in the shadows of private markets.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the SEC tighten these exemptions. Section 926 of the Act specifically required the SEC to issue rules that disqualify securities offerings involving felons or other “bad actors” from relying on Regulation D exemptions.
The SEC implemented these changes in 2013, amending Rule 506 of Regulation D. From that point forward, companies seeking to raise capital under Rule 506(b) or Rule 506(c) had to ensure that no “covered persons” associated with their offering had a disqualifying event in their past. This shift marked a significant evolution in private fundraising. The rule didn’t just punish past misconduct—it established a proactive filter to prevent repeat offenses, bringing greater integrity and investor confidence to the private market landscape.
Who Counts as a “Bad Actor”?
The term “bad actor” might sound broad, but under SEC regulations, it has a very specific legal meaning. The rule applies to a defined set of individuals and entities known as “covered persons.” These include:
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The issuer itself (the company raising capital).
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Its directors, executive officers, and general partners.
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Managing members of the issuer (if it’s a limited liability company).
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Beneficial owners of 20% or more of the issuer’s voting securities.
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Promoters connected to the offering.
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Investment managers and principals of pooled investment funds.
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Anyone compensated for soliciting investors, such as placement agents or brokers, and their directors or officers.
If any of these covered persons has a history of certain legal or regulatory violations, the company may be disqualified from using Reg D exemptions. The specific disqualifying events include a range of offenses, from criminal convictions for securities fraud to court injunctions, final orders from financial regulators, suspensions by industry organizations, and SEC cease-and-desist orders. Even being subject to certain disciplinary actions by state or federal agencies can trigger disqualification. In short, the rule doesn’t just target the company—it scrutinizes the entire network of individuals involved in the offering. This ensures that bad actors can’t hide behind a clean corporate shell or act through intermediaries.
How the Bad Actor Rule Affects Reg D Offerings
The implications of the Bad Actor Rule are profound. For companies relying on Regulation D to raise capital, compliance is not optional—it’s foundational. The rule primarily impacts Rule 506(b) and Rule 506(c) offerings, the most commonly used exemptions under Reg D.
Rule 506(b) allows issuers to raise unlimited capital from accredited investors and up to 35 non-accredited but sophisticated investors, provided there’s no general solicitation. Rule 506(c), introduced later, allows general solicitation but limits participation to verified accredited investors. Both exemptions are invaluable for startups, venture funds, and private companies—but both are off-limits if a disqualifying event exists among any covered persons. If the SEC determines that a covered person involved in a Reg D offering has a disqualifying history, the entire exemption is invalidated. That means the company loses its protection under Reg D and could be in violation of securities law for selling unregistered securities. The consequences can include enforcement actions, rescission rights for investors (forcing the company to return funds raised), and significant reputational damage. Even unintentional non-compliance can derail a fundraising round. Investors and due diligence teams now expect issuers to verify their eligibility proactively before launching any offering. This has made background checks, legal reviews, and compliance protocols an integral part of every serious Reg D campaign.
The Disqualification Process and Exceptions
While the Bad Actor Rule is strict, it isn’t absolute. The SEC recognizes that some violations may not justify permanent exclusion from Reg D eligibility. There are specific exceptions, waivers, and grandfathering provisions designed to prevent the rule from being overly punitive.
For example, disqualifying events that occurred before September 23, 2013—the date the rule took effect—don’t automatically disqualify an offering. However, companies must disclose those prior events to investors in writing before any purchase. The SEC also has the authority to grant waivers if it believes disqualification would be disproportionate or unnecessary. These waivers are typically issued when the violation was minor, unintentional, or unrelated to the offering at hand. In some cases, the person or entity may have already taken corrective measures or demonstrated a clean record since the incident.
Moreover, if an issuer can show that it didn’t know and couldn’t have reasonably known about a disqualifying event, it may avoid disqualification. This is known as the “reasonable care” exception. It underscores the importance of due diligence—companies must take active steps to verify the backgrounds of all covered persons, document those efforts, and maintain transparency with regulators and investors alike.
Due Diligence: The Frontline of Compliance
The Bad Actor Rule has fundamentally changed how private companies approach compliance. It’s no longer enough to focus on product development and fundraising strategy—founders must now think like regulators. Before launching a Reg D offering, issuers are expected to perform thorough background checks on all covered persons. This includes examining SEC enforcement actions, court records, FINRA databases, and state regulatory filings. Many companies partner with compliance firms that specialize in conducting “bad actor” screenings to ensure every participant passes the test. Documentation is critical. Even if no disqualifying events are found, issuers should retain records proving that they conducted reasonable due diligence. This paper trail can be invaluable if questions arise later about compliance or eligibility.
The process may seem burdensome, but it serves a vital purpose: maintaining investor trust. In private markets where transparency is often limited, the assurance that a company has vetted its leadership and intermediaries helps investors feel protected and confident. For companies raising multiple rounds under Reg D, this diligence should be ongoing. Any changes in leadership, ownership, or partnerships can introduce new covered persons who need to be screened. The Bad Actor Rule isn’t a one-time hurdle—it’s a continuous responsibility.
The Broader Impact on Investor Confidence and Market Integrity
The Bad Actor Rule does more than disqualify wrongdoers—it helps elevate the entire private investment ecosystem. By weeding out individuals and firms with a record of misconduct, the rule reduces the risk of fraud, enhances transparency, and fosters a culture of accountability. For investors, this creates a safer environment. They can participate in private placements knowing that the SEC has built-in mechanisms to filter out bad actors before they even enter the playing field. This protection is especially important given the rise of online fundraising platforms and general solicitation under Rule 506(c), where offerings are now visible to a broader audience than ever before.
For issuers, compliance with the rule can become a competitive advantage. Demonstrating a clean record and robust governance practices signals professionalism and reliability. It reassures investors that the company isn’t cutting corners, which can help attract institutional capital and build long-term credibility. Ultimately, the Bad Actor Rule reinforces the idea that private markets can be both dynamic and disciplined. It ensures that innovation isn’t undermined by misconduct—and that trust remains the cornerstone of every transaction.
Looking Ahead: The Future of Compliance in Private Markets
As the private investment landscape evolves, the Bad Actor Rule continues to adapt. The SEC periodically revisits its regulations to account for changes in how capital is raised, particularly with the rise of digital assets, crowdfunding, and global participation. In the future, compliance tools may become even more automated. Blockchain-based identity verification, artificial intelligence-driven background checks, and integrated compliance platforms could streamline the process, making it easier for companies to verify eligibility in real time.
However, as technology expands access to capital, it also increases the importance of maintaining ethical standards. The Bad Actor Rule will remain a central pillar of that effort—reminding companies that integrity must scale alongside innovation. For founders, the takeaway is clear: compliance isn’t just a box to check—it’s a brand value. Investors don’t just back great ideas; they back trustworthy teams. By understanding and embracing the principles behind the Bad Actor Rule, companies can raise capital confidently, ethically, and sustainably.
Integrity Is the New Currency
In a marketplace driven by innovation and speed, the Bad Actor Rule stands as a reminder that integrity never goes out of style. It protects investors, strengthens market credibility, and ensures that the spirit of Regulation D—a balance between opportunity and accountability—remains intact. For companies, it’s both a challenge and an opportunity: a challenge to maintain rigorous compliance and an opportunity to stand out as a trustworthy participant in an ever-expanding global capital ecosystem. The Bad Actor Rule doesn’t just ask, “What can you raise?” It asks, “Who are you raising it from—and how do you conduct yourself while doing it?” Those who answer with transparency and ethics will not only meet the standard but set the example for the next generation of capital raisers.
