Bad Actor Disqualification Under Rule 506: What Every LP Should Check Before Wiring Capital

TL;DR: Rule 506 of Regulation D lets private companies and funds raise capital without SEC registration, but there's a gate most retail-facing explainers skip: the SEC's "bad actor" disqualification rule, 17 CFR 230.506(d). If the issuer, its GP, or certain other insiders have a disqualifying securities violation on their record within a defined lookback window, the whole offering loses its exemption. As an LP or angel, you can actually check this yourself before you wire money. I'll show you how.

What Rule 506(d) actually says: who counts as a "covered person"

Congress told the SEC to write this rule. Section 926 of the Dodd-Frank Act ordered the Commission to bar "felons and other bad actors" from Regulation D offerings, and the SEC adopted the final version on July 10, 2013, effective September 23, 2013. It sits inside Rule 506 as two new paragraphs: 506(d), which disqualifies the offering, and 506(e), which requires disclosure of pre-2013 events that don't rise to disqualification. Before this rule existed, Rule 506 had zero bad-actor screening. A convicted felon could run a fund, sell you a limited partnership interest, and the SEC exemption stayed intact. That's the gap Dodd-Frank closed.

Here's the mechanic that matters to you as an investor. The disqualification doesn't just apply to "the company." It applies to a defined list of "covered persons," and if any one of them has a disqualifying event, the entire offering, both 506(b) and 506(c), loses the exemption for every investor in it, not just the ones who dealt with the bad actor.

Covered persons include:

• The issuer itself, plus any predecessor or affiliated issuer
• Directors, executive officers, and other officers who participate in the offering
• General partners and managing members of the issuer
• Any beneficial owner of 20% or more of the issuer's outstanding voting equity, calculated by voting power
• Any promoter connected to the issuer at the time of the sale
• The investment manager of a pooled investment fund, and that manager's own general partners, managing members, directors, and participating officers
• Anyone paid, directly or indirectly, to solicit purchasers (meaning placement agents and finders), plus their general partners, managing members, and participating officers

Notice the 20% threshold. Regulation A uses a 10% beneficial-ownership trigger; Rule 506(d) sets the bar at 20% for Regulation D. That's a meaningfully more permissive line, and it means a minority co-investor who owns 15% of a deal's equity is not, by itself, a covered person you need to vet under this rule, though I'd still want to know who they are. If you're doing angel investing due diligence on a syndicate, ask who actually crosses that 20% line, because that's where the SEC drew its own enforcement boundary.

The placement agent category deserves its own sentence. If a fund hires a third-party solicitor to raise capital, a common structure for smaller GPs without in-house distribution, that solicitor's bad-actor history is now the fund's problem too. A 2013 SEC guidance memo cited by Ropes & Gray's client alert on the bad actor CDIs confirmed that "solicitor" is not limited to registered broker-dealers. It captures anyone paid to bring in investors, registered or not. That's exactly why checking the placement agent independently matters as much as checking the GP, and why FINRA broker-dealer registration status is one of the first things worth pulling.

The specific disqualifying events and lookback periods

The rule lists seven categories of triggering events, each with its own lookback period measured from the date the event occurred (the conviction, the order, the injunction), not from the date of the underlying misconduct. A GP who committed fraud in 2014 but wasn't convicted until 2021 has a lookback clock that starts in 2021, not 2014. That timing rule comes straight from the text of 17 CFR 230.506(d) itself, hosted by Cornell's Legal Information Institute.

Disqualifying event	Lookback period
Felony or misdemeanor conviction connected to securities purchase/sale, a false SEC filing, or conduct as an underwriter/broker/dealer/investment adviser	10 years (5 years for the issuer, its predecessors, and affiliated issuers)
Court injunction or restraining order tied to securities fraud, false filings, or broker-dealer/adviser misconduct, still in effect at time of sale	5 years
Final order from a state securities, banking, insurance, or credit union regulator, a federal banking agency, the CFTC, or NCUA that bars the person or is based on fraud/deception	10 years
SEC order under Exchange Act Section 15(b)/15B(c) or Advisers Act Section 203(e)/(f) suspending or revoking registration, or barring the person	In effect at time of sale (no fixed years, tied to order duration)
SEC cease-and-desist order for violating a scienter-based anti-fraud provision (Securities Act 17(a)(1), Exchange Act 10(b)/Rule 10b-5, Advisers Act 206(1))	5 years
Suspension or expulsion from a self-regulatory organization such as FINRA, or a bar from associating with an SRO member	In effect at time of sale
SEC stop order or Reg A suspension order on a registration statement the person filed or underwrote	5 years

One nuance the SEC's own compliance guide flags: an injunction that was entered four years before the offering but was lifted before the offering happened is not disqualifying, even though it falls inside the five-year window. The rule cares whether the order is currently in effect, not just whether it's recent. And the SEC's own waiver-policy page confirms that a Commission order to pay civil money penalties alone, with no other sanction attached, does not trigger disqualification. That surprises a lot of people who assume any SEC settlement is fatal.

A real case: Och-Ziff and the waiver mechanism

The disqualification isn't automatic and permanent. Rule 506(d)(2)(ii) lets the SEC waive it "upon a showing of good cause," and the Division of Corporation Finance has delegated authority to grant these waivers. This isn't theoretical. Look at Och-Ziff Capital Management.

In September 2016, the SEC issued a cease-and-desist order against Och-Ziff Capital Management Group LLC and its adviser, OZ Management LP, over a Foreign Corrupt Practices Act matter. The firm had used investor funds to pay bribes to foreign officials and engaged in self-dealing, violating Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act. The order came with $173,186,178 in disgorgement, $25,858,989 in prejudgment interest, and a three-year monitorship. Because the order limited OZ Management's activities under Advisers Act Section 203(e), it triggered automatic disqualification under Rule 506(d)(1)(iv)(B) for every Och-Ziff fund relying on Rule 506 to sell limited partnership interests.

Och-Ziff's outside counsel filed a waiver request, according to the firm's June 2019 letter posted on SEC.gov. The letter argued the misconduct didn't involve the actual offer or sale of securities to Och-Ziff's fund investors, that founder Daniel Och was stepping back from an executive-officer role, and that the firm had never before sought a regulatory waiver in 24 years. The stakes were concrete and disclosed in the filing. Och-Ziff had been operating under the disqualification since 2016, unable to raise new Rule 506 capital in the interim, which the firm called a direct, ongoing harm rather than a hypothetical one.

Och-Ziff isn't an outlier in seeking relief. The SEC's public no-action file shows waivers granted to Guggenheim Partners Investment Management in 2015 after an Advisers Act cease-and-desist order, to National Asset Management in 2015 conditioned on completing a compliance-consultant undertaking, and to Morgan Stanley Smith Barney in January 2017 following its own Section 15(b) and Advisers Act order. In each case the Division's public order lists the same evaluation factors: whether the misconduct involved securities fraud, whether it was scienter-based, who inside the firm was responsible, and what remedial steps followed. A firm with a criminal conviction or a fraud finding directly tied to selling securities faces, in the SEC's own words, "a significantly greater" burden to get a waiver than one with a non-fraud administrative violation.

I'll be straight with you about the limits of what's publicly searchable here. The SEC does not maintain a single, easily browsable database of every 506(d) disqualification event or every denied waiver request. What you can find are the granted waiver orders and no-action letters posted on SEC.gov, plus the underlying enforcement releases that triggered them. If a GP tells you "we've never had an issue," that claim is worth testing against the same public record Och-Ziff's own lawyers cited.

The "reasonable care" exception and the Rule 506(e) disclosure duty

The rule includes a safety valve for issuers who genuinely didn't know. Under Rule 506(d)(2)(iv), disqualification doesn't apply if the issuer "did not know and, in the exercise of reasonable care, could not have known" that a covered person had a disqualifying event. But the SEC attached a hard condition to that defense: an issuer can't claim reasonable care unless it actually made a factual inquiry into whether disqualifications exist. Silence isn't a defense. Not asking is the failure.

The SEC's Division of Corporation Finance clarified in December 2013 guidance, summarized by Ropes & Gray and by Wiggin and Dana's client alert on the same CDIs, that funds making continuous offerings, most hedge funds and open-ended vehicles, have to refresh this diligence periodically, using bring-down certifications, updated questionnaires, negative consent letters, and repeated database checks. A one-time check at fund formation isn't enough for a fund still raising capital three years later.

Then there's the separate disclosure duty under Rule 506(e), which is easy to confuse with 506(d) but does something different. Disqualifying events that happened before September 23, 2013 don't disqualify the offering; the rule isn't retroactive that way. But the issuer still has to tell you about them in writing, a reasonable time before you invest. If a GP had an SEC cease-and-desist order in 2011 for conduct that would qualify as disqualifying today, that fact has to be disclosed to you even though it doesn't block the deal. Ask for that disclosure directly. If it doesn't exist in the deal documents, either there's nothing to disclose, or nobody did the inquiry Rule 506(e) requires.

This is a good moment to flag something for your regulatory compliance checklist more broadly: a GP who can't produce a bad-actor certification isn't necessarily hiding something, but they also haven't done the legal homework Rule 506 assumes they've done. That's a process failure you're entitled to ask about before you sign a subscription agreement.

Your DIY due diligence checklist before wiring capital

You don't need a securities lawyer to run the first pass yourself. Securities attorneys Charles Kaufman and Jor Law laid out a phased professional diligence framework in their Crowdfund Insider series on bad-actor due diligence, and the retail version of that same logic works for you as an investor. Here's what I check, in order, before I commit capital to a fund or a direct deal relying on Rule 506:

• Run FINRA BrokerCheck on the placement agent, any named solicitor, and any individual described as helping raise the round. BrokerCheck shows regulatory actions, terminations, and customer disputes going back years, free, at brokercheck.finra.org.
• Search the SEC's Investment Adviser Public Disclosure (IAPD) database at adviserinfo.sec.gov for the fund manager and the management company itself. Look at Item 11 of Form ADV Part 1, which specifically asks about disciplinary events.
• Ask the GP directly, in writing, whether they've certified no Rule 506(d) disqualifying events exist for the issuer and every covered person. A fund with real compliance infrastructure will have a bad-actor questionnaire on file and will send it to you without hesitation.
• Ask whether any pre-2013 events exist requiring Rule 506(e) disclosure. If the answer is "we've never checked," that's your answer about their diligence practices generally.
• Search the SEC litigation releases and administrative proceedings pages for the names of the GP, the fund manager entity, and any 20%+ owners you can identify from the offering documents.
• Check for any SEC waiver orders tied to the manager's name if something in the above turns up an enforcement history. A waiver means the SEC reviewed the misconduct and decided it wasn't disqualifying, which is different from the issue never having existed.
• Confirm who counts as a 20% beneficial owner in the cap table before the raise closes, since that ownership threshold determines who else needs to be checked.

None of this replaces counsel for a complicated fund structure with multiple feeder vehicles or overseas general partners. But for a straightforward angel check or a single-fund LP commitment, these seven steps take under an hour and they're the same public records the SEC itself relies on when it evaluates a waiver request. Rule 506(d) gave you a gate that's supposed to keep bad actors out before you ever get a chance to invest. Don't assume the gate worked. Check it yourself.

Frequently Asked Questions

What is Rule 506(d) and why does it matter to LPs?

Rule 506(d) is the SEC's bad-actor disqualification rule under Regulation D, adopted July 10, 2013 and effective September 23, 2013, per Dodd-Frank Section 926. If the issuer, its GP, or another covered person has a disqualifying securities violation within the lookback window, the entire offering loses its exemption for every investor, not just those tied to the bad actor.

Who counts as a covered person under Rule 506(d)?

Covered persons include the issuer and its affiliates, directors and participating officers, general partners and managing members, any beneficial owner of 20% or more of voting equity, promoters, the investment manager and its own officers, and anyone paid to solicit purchasers. That 20% threshold is more permissive than Regulation A's 10% trigger, so a 15% co-investor isn't automatically a covered person.

Can a disqualified issuer still raise capital through a waiver?

Yes. Rule 506(d)(2)(ii) lets the SEC waive disqualification for good cause. Och-Ziff Capital Management got a waiver in 2019 after a September 2016 cease-and-desist order tied to $173,186,178 in disgorgement and $25,858,989 in prejudgment interest had blocked it from raising Rule 506 capital since 2016. Guggenheim, National Asset Management, and Morgan Stanley Smith Barney received similar waivers.

Author Disclosure: Jeff Barnes, MBA has no personal position in any company, fund, or platform named in this article. Angel Investors Network has no current commercial relationship with any party mentioned. AIN provides marketing and education services, not investment advice. Past performance does not guarantee future results. All investments involve risk, including loss of principal.