* Proposal would ban felons from pitching private deals
* SEC has yet to finalize amid workload, disagreements
* Separate plan to lift ad ban could complicate rule
* Advocates say 'bad actor' rule must be completed first
By Sarah N. Lynch
WASHINGTON, Dec 6 It does not seem like it would
be difficult for regulators to block felons and other
law-breakers from pitching private investment deals to
unsophisticated customers, but nearly 20 months after proposing
its "bad actor" rule, the U.S. Securities and Exchange
Commission is having trouble finalizing it.
More than a year after the legal deadline for finishing its
work on the rule, the agency is stymied by internal
disagreements, limited resources and a heavy workload.
Now, state securities regulators, consumer groups and some
legislators are saying that if the SEC does not move soon, the
agency could open the door to shady late-night television
pitches from convicted criminals.
That is because of possible interplay between the so-called
bad actors rule and a second SEC proposal loosening restrictions
on the advertising of these offerings.
But with SEC Chairman Mary Schapiro leaving on Dec. 14, the
commission will be split between two Democrats and two
Republicans, making it more difficult for the agency to come to
a consensus on either rule.
The "bad actor" rule, required by the 2010 Dodd-Frank
financial reform law, would bar securities law violators from a
safe harbor that allows hedge funds and other firms to raise
cash via private offerings that are not registered with the SEC.
Aimed primarily at sophisticated, so-called "accredited"
investors, these private offerings have become increasingly
significant and one of the most common ways for companies to
The second SEC proposal, meanwhile, would allow those same
companies to advertise these private-placement investments to
general audiences, potentially via TV and the Internet.
Last week, U.S. House and Senate Republicans wrote letters
urging the SEC to finish work on the advertising rule before
The advertising proposal, required by the 2012 Jumpstart Our
Business Startups (JOBS) Act, represents a major shift from the
current practice of limiting general solicitation to protect
unwitting investors. When coupled with the safe harbor loophole,
it sets up the scenario that keeps some investor advocates up at
"When you get home on a Saturday night... and you watch a
little TV and you see a hedge fund coming at you... it would be
better if people with known disciplinary records were prohibited
from being associated from that kind of marketing," said David
Massey, North Carolina's deputy securities administrator.
To be sure, anti-fraud laws in place do require investment
sales people to disclose material legal problems to new clients.
In addition, sales of those products pitched to a general
audience still would be largely restricted to accredited
But because anyone whose net worth exceeds $1 million, or
who individually earns more than $200,000 in each of the two
most recent years is considered accredited, that means there are
a lot of potential investors for these private placements.
Some investor advocates, including U.S. Senator Jack Reed, a
key Democrat on the Senate Banking Committee, and incoming U.S.
House Financial Services Ranking Democrat Maxine Waters, say
they would like to see the SEC close the "bad actor" loophole
before loosening the advertising restrictions.
"The Commission should work swiftly to impose the 'bad
actor' disqualification before expanding the availability of
general solicitation and advertising, particularly since
Congress directed the Commission to institute this
disqualification provision nearly two years before the JOBS
Act," Waters said in an Oct. 16 letter to the SEC.
Officials at the SEC have said they hope to complete work on
the rule soon and believe it will offer important investor
"It could have the benefit of providing additional comfort
to investors... and that could lead to increased access to
capital for companies," said Meredith Cross, director of the
SEC's Corporation Finance Division, who announced earlier this
week that she plans to leave the agency at the end of the year.
SEC Commissioner Luis Aguilar, a Democrat who favors the
"bad actor" rule, said on Thursday he agrees it should be
adopted "as soon as possible," noting it should be done "before
any lifting of the ban on general solicitation."
SHOULD OLD PROBLEMS COME HOME TO ROOST?
The main controversy is an internal SEC dispute about
whether people with pre-existing legal problems -- black marks
that pre-date the Dodd-Frank law -- should be subject to the
rule. When the rule was first proposed in May 2011, two
Republican commissioners, Troy Paredes and then-commissioner
Kathleen Casey, dissented and suggested it should not allow
those backward looks.
For well over a decade, state securities regulators have
been raising concerns about the potential for fraudsters to
reach unsuspecting investors through the safe harbor known as
Rule 506 of Regulation D.
Regulation D contains a series of exemptions that let
companies avoid registering their securities. Rule 506 lets
companies raise an unlimited amount of money from accredited
These offerings were originally conceived as a way to lower
the cost of raising capital for small new companies, but they
have grown astronomically. In the fiscal year ending September
30, 2010, the SEC received more than 17,000 initial Reg D
filings, and 93 percent of them claimed the 506 exemption.
Unlike some rules under Dodd-Frank which are voluntary, the
"bad actor" rule is mandatory, and should have been completed no
more than a year after the July 2010 law was enacted. The SEC
had proposed an earlier version of the rule in 2007, but it was
never made final.
The current proposal would prohibit a wide array of
companies, directors and placement agents from conducting 506
offerings if they were convicted of, or faced civil actions such
as court injunctions and restraining orders in connection with,
securities law violations.
If the rule were applied retroactively, defendants who had
already settled cases with state or federal regulators could
suddenly find themselves banned from privately raising capital
-- something they never expected at the time the deal was inked.
Not everyone agrees with critics who think that it is
crucial to finalize the rule quickly.
Merely telling bad actors they cannot qualify for a Reg D
exemption will not deter them if they are already intent on
breaking the law, said Covington & Burling law firm partner
David Martin, who previously served as the SEC's corporation
"I don't think it solves that much," he said.