Compliance check: why do you need a Bad Actor report?

"A discerning man in business attire reviews a document with a pensive expression against a bright blue background featuring a question about the necessity of a bad actor report

Companies seeking innovative funding options beyond traditional bank loans or venture capital investments. Regulation A (RegA+), Regulation Crowdfunding (RegCF), and Rule 506c of Regulation D present viable alternatives. 

In this context, while navigating the offering, and compliance with SEC is paramount. One of the most important requirements is the exclusion of “Bad Actors”, a measure to safeguard all the parties involved in the process of raising capital.

Who are Bad Actors?

In the context of securities offerings, “Bad Actors” are individuals or entities with a history of fraudulent activity, particularly involving securities. This can include:

  • Individuals with past convictions for securities fraud.
  • Companies that issued misleading financial statements.
  • Individuals sanctioned by regulatory bodies for financial misconduct.

In other words, those who fall under this disqualification include the company issuing the securities, its officers, directors, significant shareholders, and individuals compensated by the company to solicit or promote the offering.

Also worth mentioning that the criteria for designating someone as a “Bad Actor” encompass eight types of disqualifying events, such as civil and criminal judgments, orders from state and federal administrative bodies, and directives from regulatory authorities. 

How to Avoid Disqualification: “Reasonable Care” and Bad Actor Reports

The SEC offers a “reasonable care” exception to disqualification. This means companies can still raise capital under Regulation A or crowdfunding if they can demonstrate they took reasonable steps to identify and exclude Bad Actors.

There’s no central database for “Bad Actors,” so conducting a thorough “factual inquiry” is crucial. Bad Actor reports from reputable third-party services can significantly help with this process. These reports compile information on individuals and entities, identifying potential disqualifying events based on available data sources.

Examples of Legal Implications of Non-Compliance

The SEC takes violations of Bad Actor disqualification rules seriously. Failing to comply can lead to significant legal and financial repercussions for your company. In severe cases, the SEC might bring criminal charges against those involved.

Understanding these potential consequences highlights the importance of prioritizing compliance practices.

  • Civil and Criminal Penalties: Non-compliance can lead to civil penalties, such as fines or sanctions, and in severe cases, criminal charges. These penalties are designed to deter violations and promote adherence to securities laws.
  • Suspension or Revocation of Securities Registration: If your company is found non-compliant, it could face the suspension or revocation of its registration to issue securities. This would halt any ongoing fundraising activities and could severely impact future capital-raising capabilities.
  • Loss of Exemption Privileges: Companies failing to screen for Bad Actors may lose their exemption status under regulations like Rule 506 of Regulation D, Regulation Crowdfunding, or Regulation A. Losing this status can complicate future efforts to raise capital without the extensive requirements of a full SEC registration.
  • Legal Actions from Investors: Investors may pursue legal action if they suffer losses due to the company’s involvement with Bad Actors. Such lawsuits can be costly and damage the company’s reputation.
  • Reputational Damage: Beyond financial and legal repercussions, the presence of Bad Actors can tarnish a company’s reputation, making it difficult to attract future investors or business partners. Maintaining a clean compliance record is crucial for preserving trust and credibility in the market.
  • Restrictive Orders: The SEC may issue cease-and-desist orders or other restrictive actions, limiting the company’s operations in the securities market. These orders could restrict certain business practices or the issuance of securities.
  • Disclosure Obligations: If disqualifying events occur, companies may be required to make extensive disclosures in their offering materials, which could deter investor interest and affect the overall success of the offering.

The knowledge of these implications helps emphasize the necessity of conducting thorough due diligence and implementing effective compliance measures to protect your company from potential legal challenges and to maintain its good standing in the financial market.

Proactive Measures for Compliance

Avoiding Bad Actor disqualification necessitates a proactive approach:

  1. Thorough Background Checks: Prior to any offering, conduct comprehensive background checks on all involved parties, including officers, directors, and major shareholders. Identifying any past disqualifying events is essential for maintaining eligibility for exemptions.
  2. Utilize Professional Services: Engage reputable firms like CrowdCheck to conduct in-depth investigations and provide detailed reports on covered persons. These reports offer insights into any potential disqualifications, helping companies demonstrate compliance with SEC and FINRA standards.
  3. Exercise Reasonable Care: Implement robust procedures for factual inquiries into the backgrounds of all participants. By demonstrating a commitment to due diligence, companies can establish a defense of “reasonable care” in the event of unforeseen disqualifications.
  4. Ongoing Monitoring: Regularly review and update compliance protocols to adapt to evolving regulatory requirements.  Stay informed about changes in SEC, FINRA regulations, and industry best practices to ensure ongoing adherence to standards.

By adopting proactive measures, companies can mitigate the risk of Bad Actor disqualification and uphold investor confidence in their offerings.

 

Conclusion: Emphasizing Due Diligence in Investments

Innovative funding options like Regulation A (RegA+) and RegCF crowdfunding offer promising opportunities for startups and small businesses to raise capital. However, these avenues come with inherent risks, necessitating careful attention to compliance and investor protection.

A proactive approach to identifying and excluding Bad Actors is essential for companies seeking to raise capital. By conducting thorough due diligence, utilizing third-party services, and maintaining transparency, companies can mitigate risks and instill confidence in investors, ultimately fostering a thriving and trustworthy investment ecosystem.

 

Disclaimer: This article is for informational purposes only and is not intended as financial advice.