When the Securities and Exchange Commission adopted Rule 506(d), it did not define “voting equity securities.” That left many fund managers having to take an aggressive approach on compliance with the “bad actor rule.” The SEC has provided some additional clarity.
I have to admit that I did not pay much attention to the recent rule release for Regulation A. I’m skeptical that it’s a particularly useful fundraising tool for funds. Also, Regulation recently came under siege from state securities regulators.
It turns out that the SEC buried some clarification about Rule 506(d) in the release for the updated Regulation A. If you don’t want to read all 450+ pages of the rule release, just turn to page 203 for the discussion of the change.
The SEC has reconsidered its initial interpretation as it applies to the bad actor rule in 506(d) and created a bright-line test. (As a compliance professional, I like bright-line tests.)
Previously the SEC consider securities as voting equity securities if:
“securityholders have or share the ability, either currently or on a contingent basis, to control or significantly influence the management and policies of the issuer through the exercise of a voting right.”
I think most people looked at this and said if you have or could possibly have 20% of anything in the company, you fall within the bad actor rule. The SEC decided this interpretation was too broad and wanted a definition that would “facilitate compliance.”
The new definition:
In this regard, we believe that such a term should include only those voting equity securities which, by their terms, currently entitle the holder to vote for the election of directors. In other words, we believe the term should be read to denote securities having a right to vote that are presently exercisable. Additionally, while the ability to control or significantly influence the management or policies of the issuer may be derived in part from the power to vote for the election of directors, in order to dispel any uncertainty as to the scope of our interpretation, we believe the term “voting equity securities” should be interpreted based on the present right to vote for the election of directors, irrespective of the existence of control or significant influence.
That is a great change, making the definition more narrow. A great change that is limited to investment vehicles formed as corporations.
Of course, the SEC flubbed and used the term “directors” in this definition. That leaves fund compliance professionals scratching their heads as to how this interpretation applies to a private fund, which is typically organized as a limited partnership.
I think you have to ignore it. You can argue that a right of limited partners to remove the general partner without fault is the equivalent to the right to elect a director of a corporation. I’m just not sure you win that argument. It certainly make the bright line test much more blurry.
Sources:
- Amendments for Small and Additional Issues Exemptions under the Securities Act, Securities Act Release No. 9741 (March 25, 2015) (pp. 203-204 for the intepretation)
- SEC Clarifies “Voting Equity Securities” for Purposes of the Bad Actor Rules from Ropes & Gray
- Massachusetts securities regulator William Galvin sues SEC over small-company offerings
Vote by Theresa Thompson
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